SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


FORM
10-K




x   ANNUAL REPORT
UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934





For the
fiscal year ended: DECEMBER 31, 2008





o   TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934





For the
transition period from ______________ to ______________





Commission
File Number: 0-13092





SPECTRASCIENCE,
INC.





(Name of
small business issuer in its charter)




MINNESOTA
            
            41-1448837(State
      of incorporation)
            
            (I.R.S.
      Employer Identification No.)




11568-11
      Sorrento Valley Road, San Diego, CA
            
            92121(Address
      of principal executive offices)
            
            (Zip
      Code)




Issuer’s
telephone number: (858) 847-0200





Securities
registered under Section 12(b) of the Exchange Act: NONE





Securities
registered under Section 12(g) of the Exchange Act:


COMMON
STOCK, $0.01 PAR VALUE


(Title of
Class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.





Yes           o           No           x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Exchange Act.





Yes           o           No           x





Indicate
by check mark whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.


Yes           
x           No           
o





Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is not contained
herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. x





Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company:





Large accelerated filer
             ̈
            Accelerated filer
             ̈
            Non-accelerated filer
             ̈
            Smaller reporting company
            x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).





Yes            o
            No
            x




Registrant’s
revenues for each of its fiscal years ended December 31, 2008 and 2007 were
$60,560 and $0, respectively. The aggregate market value of the voting Common
Stock held by non-affiliates, computed by reference to the price at which the
voting Common Stock as of the last business day of the Company’s most recently
completed second fiscal quarter is $25,019,996. There is no non-voting Common
Stock.





REGISTRANTS
INVOLVED IN BANKRUPTCY


PROCEEDINGS
DURING THE PAST FIVE YEARS





Indicate
by check mark  whether the issuer has filed all documentation and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.





Yes           
x            No           o





As of
March 25, 2009 the number of outstanding shares of the Registrant’s Common
Stock, par value $0.01 per share, was 69,696,653.





DOCUMENTS
INCORPORATED BY REFERENCE





None.


2





SPECTRASCIENCE,
INC.





FORM
10-K


For
the Fiscal Year Ended December 31, 2008





TABLE OF
CONTENTS




PagePART
      IItem
      1. Description of Business
                      
                      
                      4Item
      1A. Risk Factors
                      
                      
                      15Item
      1B. Unresolved Staff Comments
                      
                      
                      23Item
      2. Description of Property
                      
                      
                      23Item
      3. Legal Proceedings
                      
                      
                      23Item
      4. Submission of Matters to a Vote of Security Holders
                      
                      
                      23PART
      IIItem
      5. Market for Registrant’s Common Equity, Related Stockholder Matters and
      Issuer
                        Purchases of Equity Securities
                      
                      
                      23Item
      6. Selected Financial Data
                      
                      
                      25Item
      7. Management's Discussion and Analysis of Financial Condition and Results
      of Operations
                      
                      
                      25Item
      7A. Quantitative and Qualitative Disclosures About Market
    Risk
                      
                      
                      29Item
      8. Financial Statements and Supplementary Data
                      
                      
                      29Item
      9. Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure
                      
                      
                      47Item
      9A(T). Controls and Procedures
                      
                      
                      48Item
      9B. Other Information
                      
                      
                      48PART
      IIIItem
      10. Directors, Executive Officers and Corporate Governance
                      
                      
                      49Item
      11. Executive Compensation
                      
                      
                      53Item
      12. Security Ownership of Certain Beneficial Owners and Management and
      Related Stockholder
                        Matters
                      
                      
                      55Item
      13. Certain Relationships and Related Transactions and Director
      Independence
                      
                      
                      57Item
      14. Principal Accountant Fees and Services
                      
                      
                      57Item
      15. Exhibits and Financial Statement Schedules
                      
                      
                      57SIGNATURES
                      
                      
                      59





FORWARD-LOOKING
STATEMENTS





Certain
statements in this Annual Report on Form 10-K constitute “forward-looking
statements” within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
When used in this Report, or in our future filings with the SEC, in our press
releases and in oral statements made with the approval of an authorized
executive officer, the words or phrases “anticipates,” “estimates,” “expects,”
“will likely result,” “projects,” “believes,” “intends,” or similar expressions
are intended to identify such forward-looking statements, but are not the
exclusive means of identifying such statements. These forward-looking statements
involve risks and uncertainties that may cause our actual results to differ
materially from the results discussed in the forward-looking
statements.





We
caution you not to place undue reliance on these forward-looking statements,
which speak only as of the date made. We undertake no obligation to revise any
forward-looking statements in order to reflect events or circumstances after the
date of such statements. Readers are urged to carefully review and consider the
various disclosures made by us in this report and other reports we file with the
SEC that attempt to advise interested parties of the risks and factors that may
affect our business.


3





PART
I





ITEM 1.
DESCRIPTION OF BUSINESS.





Introduction





SpectraScience,
Inc. (“SpectraScience”) was incorporated in the State of Minnesota on May 4,
1983 as GV Medical, Inc. In October 1992, GV Medical discontinued its prior
business, refocused its development efforts and changed its name to
SpectraScience, Inc. The “Company”, hereinafter refers to SpectraScience, Inc.
and its wholly-owned subsidiary, Luma Imaging Corporation. From 1996 until
filing for bankruptcy in 2002, the Company focused on developing the
WavSTAT® Optical
Biopsy System (“WavSTAT”). The WavSTAT  is
a proprietary, minimally invasive technology that optically scans tissue in
real-time to distinguish between normal and pre-cancerous or cancerous tissue,
without the need to remove tissue from the body.





Our
principal executive offices are located at 11568 Sorrento Valley Rd., Suite 11,
San Diego, CA 92121. You can reach us by telephone at (858) 847-0200; by fax at
(858) 847-0880; or by email at info@spectrascience.com. Our website address is
http://www.spectrascience.com, however the information contained on our web site
is not deemed to be a part of this document.





Reorganization





The
Company adopted “fresh-start reporting” effective August 2, 2004, given the
absence of any operating activity or other significant activity for almost two
years, in accordance with the guidelines of the A.I.C.P.A.’s Statement of
Position 90-7, “Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code” (“SOP 90-7”).





The
Company received funding and commenced operations effective August 2, 2004 and
as of that date (for purposes of this Report, the “Effective Date”) the Company
became the “Successor Company.” The Company as it existed prior to August 2,
2004, is referred to as the “Predecessor Company.”





Acquisition
of Luma Imaging Corporation Assets





On
November 6, 2007, the Company acquired 100% of the shares of Luma Imaging
Corporation (“LUMA â”)
from its shareholders in consideration for 11.2 million restricted shares of
SpectraScience common stock (see Note 1 of the accompanying consolidated
financial statements).





LUMA had
developed and received approval from the US Food and Drug Administration (the
“FDA”) for an optical, non-invasive diagnostic imaging system that is proven to
more effectively detect cervical cancer precursors than using conventional means
alone (i.e. colposcopy). The LUMA Cervical Imaging System utilizes a single-use
disposable probe and requires little additional training as it leverages
clinician’s existing skill sets. When used as an adjunct to colposcopy, LUMA
detects significantly more high-grade cervical cancer precursors than colposcopy
alone.




The
transaction was accounted for as an acquisition of assets that included
intellectual property, inventory and equipment. The intellectual property
consists of a total of 34 issued US Patents and 18 additional patent
applications.




Products and
Markets




SpectraScience
has developed a technology platform to instantly determine if tissue is normal,
pre-cancer or cancerous, without the need for exploratory biopsy. The Company
has received its first FDA approval to market its proprietary and patented
optical biopsy system capable of determining instantaneously whether colon
tissue is normal, pre-cancerous or cancerous without physically removing tissue
from the body and without waiting days for a pathology report. The Company has
also developed an additional application for the detection of pre-cancerous and
cancerous tissue in the esophagus, as well as recently expanded its product
offerings to cervical cancer and pre-cancer detection through the acquisition of
Luma Imaging Corporation.


4


The
WavSTAT operates by using cool, safe UV laser light to optically scan and
analyze tissue, enabling the physician to make an instant diagnosis during
endoscopy when screening for cancer and, if warranted, to begin immediate
treatment during the same procedure. The SpectraScience WavSTAT uses
laser-induced auto-fluorescence to obtain spectral information from tissue at
the suspected site. The system is a non-significant risk device which transmits
low-level UV laser light energy through an optical fiber to the tissue via the
working channel of an endoscope. The tissue in contact with the optical fiber
absorbs the light. The resulting tissue auto-fluorescence is collected by the
same optical fiber and returned to a detector within the WavSTAT console for
measurement. The system analyzes the spectral data and displays the results
graphically for the user as normal tissue (green light), suspected pre-cancer,
or cancer (red light). Data are recorded on a printer and saved in flash memory
and a hard drive. The WavSTAT has been tested at five leading medical centers,
including the Mayo Clinic and Massachusetts General Hospital, with results
demonstrating statistically significant improvement in physician accuracy in the
ability to detect pre-cancerous and cancerous tissue during
endoscopy.





The
WavSTAT was specifically designed to serve as a technology platform to
facilitate multiple medical applications for cancer detection. Spectra Science
sees additional opportunities for this core technology in several other large
as-yet-unexplored markets which include lung, skin, oral, prostate, breast,
urinary and bladder cancer detection. The Company is currently developing
additional applications of its platform for these markets, and is analyzing
feasibility of the use of our technology and the revenue opportunity for each
market.




Colorectal
Cancer





The
American Cancer Society reports colorectal cancer as the third most common
cancer diagnosed in the US with approximately 108,070 new cases annually. With
an estimated 49,960 deaths in 2008, colorectal cancer is second only to lung
cancer as the leading cause of cancer death in the US. Candidates for colorectal
cancer screening include all persons, with or without symptoms, over the age of
50 (or an estimated 80-90 million people in the US) with the screening market
expected to increase 20% over the next ten years. Demographic statistics for the
European Union are very similar.





Colorectal
cancer is primarily diagnosed through the discovery and histo-pathologic
analysis of polyps. Colon polyps are small masses of tissue found in the lining
of the colon that may be either benign or malignant. The most commonly performed
and generally accepted colorectal cancer screening procedure to detect polyps is
an endoscopy of the lower colon also known as a flexible sigmoidoscopy or,
alternately, a full colonoscopy. According to the American Society for
Gastrointestinal Endoscopy guidelines for colorectal cancer screening, large
polyps (greater than 1 centimeter) are generally removed as a matter of course
and sent to pathology for evaluation. On the other hand, the guidelines further
state that small polyps (less than 1 centimeter which account for approximately
85% of all polyps) require, "individualized treatment on a case by case basis".
The clinical utility of the WavSTAT occurs when the physician must decide the
best course of treatment for small polyps. When small polyps are found, it is
left to the physician's discretion based primarily on visual assessment, whether
to remove the polyp, place the patient under surveillance, or to biopsy. If a
biopsy is performed and cancer or pre-cancer is documented by pathology, the
polyp must then be removed during a second costly endoscopy
procedure.





Relative
to colorectal cancer, five-year survival rates as reported by the American
Cancer Society are as follows:





·
            Approximately
      90% of patients live five years or longer if the cancer is detected and
      treated at an early stage;




·
            Only
      68% of patients live five years or longer if the cancer spreads outside
      the polyp and colon to nearby organs or lymph nodes;
  and




·
            The
      five-year survival rate for those patients in whom the cancer has spread
      further to the liver or other organs is only
  10%.




Clearly,
early detection of colorectal cancer is essential to long-term survival.
Unfortunately, the American Cancer Society reports that only 39% of colorectal
cancers are detected at an early stage. Clinical studies indicate that
colorectal cancer screening procedures result in earlier detection and can
prevent as many as 20 to 40% of potential colorectal cancers and subsequently
reduce colorectal cancer deaths by 30 to 50%. Colorectal screening procedures
not only save lives, they also save money. If a patient is not diagnosed until
symptoms develop and the disease has spread, or if misdiagnosed at an early
stage, the chance of patient survival plummets and more advanced treatment
regimens such as surgery, chemotherapy and/or radiation become
necessary.





The
WavSTAT was specifically designed to be used during screening endoscopy of the
colon to aid and improve the physician's ability to identify small polyps as
normal, pre-cancerous or cancerous tissue in real time. Results from the
Company's FDA regulated clinical studies performed at the Mayo Clinic
(Rochester, MN), Massachusetts General Hospital (Boston, MA), Hennepin County
Medical Center (Minneapolis, MN) and Minnesota Gastroenterology P.A. (St. Paul
and Minneapolis, MN) demonstrated that using the WavSTAT during colorectal
endoscopic screening increased the physician's diagnostic accuracy in detecting
pre-cancerous or cancerous polyps by a statistically significant
amount.





Based on
the results demonstrated by these clinical studies, management believes that
using the WavSTAT will:





·
            Significantly
      improve the physician's diagnostic accuracy in determining whether small
      polyps in the colon are pre-cancerous or
  cancerous;


5





·
            Improve
      patient survival rates by earlier detection and treatment of cancers, and
      more importantly pre-cancers, by more accurately identifying cancers or
      pre-cancers the physician may
misdiagnose;




·
            Improve
      the patient's quality of life by providing an immediate analysis of the
      tissue, thereby eliminating the anxiety of waiting several days to hear
      the pathology results;




·
            Enable
      the physician to diagnose and treat the patient during the same endoscopy
      procedure with the same biopsy instrument, thereby potentially reducing
      the need for scheduling a second expensive endoscopy for treatment
      purposes;




·
            Be
      cost effective by significantly reducing the number of physical biopsies
      performed and by reducing the number of unnecessary follow-on endoscopies
      performed; and




·
            Be
      cost effective by reducing the number of misdiagnosed patients, thereby
      eliminating the need for more costly advanced treatments such as surgery,
      chemotherapy and/or radiation.




Esophageal
Cancer





Barrett’s
esophagus is a condition of the lining of the lower esophagus thought to be
caused primarily by Gastro Esophageal Reflux Disease (“GERD”), more commonly
known as chronic heartburn. Barrett’s esophagus is considered to be a
pre-malignant stage and a precursor to esophageal cancer. Physicians typically
recommend that persons with chronic heartburn should have an endoscopy to look
for Barrett’s esophagus. Some Barrett’s patients will advance further to a stage
where additional abnormal tissue called dysplasia is present. Dysplasia is known
to be the next progressive step toward esophageal cancer and is categorized as
either low-grade or high-grade.





Barrett’s
esophagus, dysplasia and esophageal cancer patients are presently diagnosed via
endoscopy of the esophagus with the physician taking multiple random physical
biopsies of the esophageal lining, a significantly invasive procedure.
High-grade dysplasia is a critical stage to correctly diagnose because
physicians frequently recommend surgical resection or removal of the esophagus
in such an event. Unfortunately for the patient, dysplasia is difficult to find
and/or diagnose because it is not reliably visible to the physician during
standard endoscopy. Accurate diagnosis is critical and, as a result, physical
biopsies (as many as 20 at once) are performed either randomly or in a geometric
pattern in the esophagus in the hope of finding the most appropriate tissue to
physically biopsy. Current medical practice typically follows the guidelines
described below:





·
            Patients
      with chronic GERD (severe heartburn) receive a screening endoscopy of the
      esophagus with multiple biopsies to check for Barrett's
      esophagus;




·
            Patients
      with Barrett's esophagus receive an endoscopy with multiple biopsies every
      year to check for dysplasia;




·
            Patients
      with Barrett's esophagus that has progressed to include low grade
      dysplasia receive an endoscopy with multiple biopsies every 6 months to
      check for high grade dysplasia; and




·
            Patients
      with Barrett's esophagus that has progressed to include high grade
      dysplasia receive an endoscopy with multiple biopsies every 3 months to
      check for cancer and/or may be referred for esophageal surgical resection,
      photodynamic therapy or electrical
ablation.





The
American Cancer Society estimated that 16,470 new cases of esophageal cancer
were diagnosed in the year 2008, with an approximate 90% mortality rate. In
addition, the rate of esophageal cancer is growing six times faster than any
other form of cancer. The relatively high death rate associated with esophageal
cancer typically results from a lack of early diagnosis with the outcome being
that the cancer has grown to an advanced stage. As described below, the
frequency of endoscopic surveillance for these patients increases as the
pre-cancerous stages advance in hopes of providing the earliest possible
diagnosis.





The
Company has developed an application for the WavSTAT for the detection of
pre-cancerous and cancerous tissue in the esophagus. Spectra Science completed a
clinical study in April 2002 using its WavSTAT for the detection of
pre-cancerous and cancerous tissue in the esophagus. This clinical trial was
designed to determine the viability of using spectroscopic techniques to detect
esophageal cancer in Barrett's patients, and to develop and demonstrate the
feasibility of the WavSTAT for this type of application. A total of 87 patients
with Barrett's esophagus were enrolled into the trial with 326 optical and
physical biopsies taken. The results of the evaluation show that we were able to
obtain a sensitivity of 95% and a specificity of 80% in determining high-grade
versus low-grade dysplasia or non-dysplastic Barrett's esophagus, suggesting
that the WavSTAT is effective in detecting pre-cancerous and cancerous tissue .
Derived from the study data, a proprietary tissue recognition software algorithm
was developed and is being used in a current trial.  The WavSTAT with
the esophageal algorithm was released for sale in the EU late in
2008.


6





The
annual potential revenue estimated for esophageal cancer and pre-cancer
detection in the US and EU is $850 million and the disposable/re-useable market
is estimated at an additional $250-650 Million.





Cervical
Cancer





Almost a
thousand women die every day worldwide from cervical cancer.  Cervical
cancer is the sixth most common form of malignancy in U.S. women, with
approximately 11,000 new cases per year. An additional 600,000 women are
identified each year as having pre-cancerous cervical disease. Early detection
of these pre-cancerous conditions allows clinicians to treat patients more
effectively, less expensively, and with fewer lasting health effects. Currently,
women with abnormal Pap tests are diagnosed with a colposcope, a decades-old,
low-powered binocular microscope technology, which provides only a limited
visual assessment of the cervix. In fact, a recent large-scale National Cancer
Institute-sponsored clinical trial demonstrated that colposcopy failed to detect
33% of high-grade precancerous lesions in women referred with questionable Pap
results. LUMA’s ability to detect close to 30% more ASCUS/LSIL cervical cancer
precursors than colposcope alone provides clinicians with a valuable tool in the
fight against cervical cancer in addition to colposcopy.





More than
four million U.S. women have abnormal Pap tests each year, and they typically
undergo a series of repeat, stressful and expensive diagnostic tests. For women
with precancerous lesions, the long diagnostic cycle can allow the disease to
progress and develop into invasive, life-threatening cancers. By providing a
more definitive objective test, it is expected that LUMA will allow clinicians
to more effectively manage and treat millions of women who are at risk of
cervical cancer.





The LUMA
provides a, non-invasive diagnostic imaging system to detect cervical cancer
precursors more effectively than using conventional means alone (i.e.
colposcopy). The LUMA utilizes a single-use disposable probe and requires little
additional training as it leverages clinicians’ existing skill sets. When used
as an adjunct to colposcopy, LUMA detects significantly more high-grade cervical
cancer precursors than colposcopy alone. Clinical trials comprised of over 3,000
  women have demonstrated LUMA’s ability to detect close to 30% more
Atypical Squamous Cell of Undetermined Significance/Low-grade Squamous
Intraepithelial Lesion (ASCUS/LSIL) cancer cell precursors than colposcopy
alone. LUMA received FDA approval as an adjunct to colposcopy in March 2006 and
the predecessor company was conducting a 950 patient post-approval study (300
were completed) to further examine its advanced detection capabilities when
placed in a practical clinical setting.




In the
U.S. alone, over $6 billion is spent annually on the screening, diagnosis and
treatment of women with cervical cancer and the colposcopy market is
approximately $1.0 billion annually. Diagnosing cervical cancer is often a long
and uncertain process, requiring repeat visits by anxious patients.
Approximately two million colposcopy procedures are performed annually in the
United States, with many repeat exams aimed at arriving at a definitive
diagnosis. The introduction of HPV-DNA testing is expected to be a catalyst for
this market, increasing the number of colposcopy procedures performed each year.
LUMA offers a reliable, easy-to-use diagnostic exam that provides rapid answers
for clinicians and their patients by greatly reducing missed diagnosis and
allowing for early-stage decision and treatment of cervical cancer
precursors.





Government
Regulation





United
States





Extensive
government regulation, both in the United States and internationally, controls
the design, manufacture, labeling, distribution and marketing of our products,
particularly regarding product safety and effectiveness. In the United States,
medical devices are subject to review and clearance or approval by the Food and
Drug Administration (FDA). The FDA regulates the clinical testing, manufacture,
labeling, distribution and promotion of medical devices. If we fail to comply
with applicable requirements, we could face:




·
            fines,
      injunctions or civil penalties




·
            recall
      or seizure of our products




·
            criminal
      prosecution




·
            a
      recommendation that we not be allowed to contract with the
      government




·
            total
      or partial suspension of production




·
            inability
      to obtain pre-market clearance/approval for our
  devices




·
            withdrawal
      of marketing approvals


7




The Food,
Drug, and Cosmetic Act, the Public Health Service Act, and Safe Medical Devices
Act of 1990 and other federal statutes and regulations also govern or influence
the testing, manufacture, safety, labeling, storage, recordkeeping, clearance,
advertising and promotion of such products.





In the
United States, medical devices are assigned to one of three classes depending on
the controls the FDA deems necessary to ensure the safety and effectiveness of
the device. The WavSTAT and LUMA are both Class III devices; this is FDA’s most
highly regulated category in the Center for Devices and Radiological Health
(CDRH). In addition to adhering to general controls to which all medical devices
are subject, and special controls such as performance standards, post-market
surveillance and patient registries, a Class III device must receive
pre-marketing approval to ensure its safety and effectiveness prior to
commercialization.





FDA
approval to distribute regulated devices can be obtained in one of two ways. If
a new or significantly modified device is “substantially equivalent” to an
existing legally marketed device, the new device can be commercially introduced
after filing a 510(k) pre-market notification with the FDA and the subsequent
issuance by the FDA of an order permitting commercial distribution. Changes to
existing devices that do not significantly affect safety or effectiveness may be
made without an additional 510(k) notification. We received 510(k) clearance
from the FDA for our disposable and reusable Optical Biopsy Forceps in December
1996.





A second,
more comprehensive approval process applies to a Class III device that is not
substantially equivalent to an existing product. First, the applicant must
usually conduct clinical trials in compliance with testing protocols and patient
“informed consent” forms approved by the Institutional Review Board (IRB or
Safety Committee) at each participating research institution. These boards
oversee and approve all clinical studies at their institutions (in some cases a
central IRB may approve studies at multiple locations). Second, a Pre-Market
Approval (PMA) application must be submitted to the FDA describing (i) the
clinical trial results, (ii) the device and its components, (iii) the methods,
facilities and controls used for manufacture of the device, (iv) proposed
labeling and advertising literature, and (v) the demonstration that the product
is safe and effective.





If the
FDA determines, upon receipt of the PMA application, that the application is
sufficiently complete to permit a substantive review, they will accept the
application for filing. Review of a pre-market approval application typically
takes from six months to two years from the date the application is accepted for
filing, but can be significantly longer. Often, during the review period, a
panel primarily composed of clinicians and acting as an advisory committee will
be convened to review, evaluate, and provide non-binding recommendations to the
FDA as to whether the device should be approved. Toward the end of the
application review process, the FDA generally will conduct an inspection of the
manufacturer’s facilities to ensure that the facilities are compliant with the
applicable Quality System Regulations requirements.





If FDA
evaluations of both the PMA application and the manufacturing facilities are
favorable, the FDA will issue either an approval letter or a conditional
approval letter which contains a number of conditions that must be satisfied in
order to secure final approval of the PMA application. When and if those
conditions are fulfilled to the satisfaction of the FDA, they will issue an
approval letter, authorizing commercial marketing of the device for certain
indications for use. If the FDA’s evaluation of the PMA application or
manufacturing facilities is not favorable, the FDA will deny approval of the
application or issue a “not approvable letter.” The FDA may also determine that
additional clinical trials are necessary, in which case pre-market approval
could be delayed for several years while additional clinical trials are
conducted and submitted in an amendment to the PMA application. The pre-market
approval process can be expensive, uncertain and lengthy, and a number of
devices for which FDA approval has been sought have never been approved for
marketing.





Any
products manufactured or distributed pursuant to FDA clearances or approvals,
are subject to pervasive and continuing regulation by the FDA, including
record-keeping requirements and reporting of adverse experiences when using the
product





Device
manufacturers are required to register their establishments and list their
devices with the FDA and certain state agencies, and are subject to periodic
inspections. The Food Drug and Cosmetic Act requires devices to be manufactured
in accordance with Quality System Requirements regulations, which impose
procedural and documentation requirements upon a manufacturer and any of its
contract manufacturers with respect to manufacturing and quality assurance
activities. The frequency and depth of inspections of PMA products are generally
more detailed and frequent than products cleared in the 510(k) process. Quality
System Requirements regulations also require design controls and maintenance of
service records. Changes in existing requirements or adoption or new
requirements or policies could adversely affect our ability to comply with
regulatory requirements. Failure to comply with regulatory requirements could
have a material adverse effect on our business, financial condition or results
of operations.





The
Company submitted a pre-market approval application for market clearance of the
WavSTAT Optical Biopsy System for use during endoscopic screening of the colon
in September 1998, and was approved by the FDA in November 2000. Based upon beta
site outcome clinical studies, features were added to the WavSTAT, and submitted
as a supplement to the original filing in September 2001. The supplement for the
WavSTAT II was approved by the FDA in November 2001. The Company submitted a
supplement for approval of WavSTAT III in February 2002 and approval was
received in August 2002. We anticipate that product improvements requiring
approval, or any new applications, such as for Barrett’s esophagus developed for
the WavSTAT 
will be submitted as supplements to the original filing rather than as original
PMA filings.


8





A similar
path was followed for the LUMA Cervical Imaging System with the original PMA
being filed by FDA on June 28, 2004. Following interactive communication with
FDA and 15 PMA amendments, the product received its PMA approval on March 16,
2006. In addition to the standard conditions of approval, an additional LUMA
approval condition was a post-approval study. When the LUMA assets were
acquired, approximately one third of the study had been completed. We are
continuing the post-approval study to meet this condition of
approval.





We are
also subject to numerous federal, state and local laws relating to such matters
as safe working conditions, manufacturing practices, environmental protection,
fire hazard control and disposal of hazardous or potentially hazardous
substances. We are not aware of any manufacturing methods for the Systems that
will require extensive or costly compliance with environmental regulations.
However, since laws change over time there can be no assurance that (i) we will
not be required to incur significant costs to comply with all applicable laws
and regulations in the future, or (ii) the impact of changes in those laws or
regulations or adoption of new laws and regulations will not have a material
adverse effect upon our ability to do business. European Union and Other
Countries





The
European Union encompasses most of the major countries in Europe. The European
Union has adopted numerous directives and standards regulating the design,
manufacture, clinical trial, labeling, and adverse event reporting for medical
devices. The principal directive prescribing the laws and regulations pertaining
to medical devices in the European Union is the Medical Devices Directive,
93/42/EEC.





Devices
that comply with the requirements of the Medical Devices Directive will be
entitled to bear the CE mark, indicating that the device complies with the
essential requirements of the applicable directive. In order to distribute a
medical device in the European Union, the product must earn and display the CE
mark. Generally, companies must also go through the ISO certification process in
order to obtain the CE mark. SpectraScience received ISO 9001 certification in
July 2000, and CE mark authorization for our products in October 2000. In order
to maintain ISO 9001 certification SpectraScience must undergo a yearly audit to
assure the European Union regulatory agencies of our compliance with ISO 9001
standards. Our last audit was in 2008, when we earned certification for an
additional standard, EN 13485:2003, which is a medical device adaptation of the
ISO 9001 standard. We are periodically re-audited to remain ISO 9001 and EN
13485 certified. There can be no assurance that we will be able to maintain
international certification or CE mark authorization for any of our products or
product components. Furthermore, even though a device bears the CE Mark,
practical complications may arise with respect to market introduction because of
differences among countries in areas such as labeling requirements and
reimbursement practices. We may be required to spend significant amounts of
capital in order to comply with the various regulatory requirements of foreign
countries and achieve reasonable payment for our products.





Product
Research and Development





The
Company invested significant capital in research and development for the fiscal
year ended December 31, 2008 as compared to prior recent history. The increase
was as a result of increased clinical trial activity, the further development of
the Barrett's software algorithm and the transition to producing systems for
sale, rather than for clinical trials. Research and development expenses were
$2,220,007 and $796,944 for the fiscal years ended December 31, 2008 and 2007,
respectively.





Compliance
with Environmental Laws





Management
has reviewed the cost of compliance with environmental laws and deemed the cost
of such appliance to be non-material for the fiscal year ended December 31, 2008
and the foreseeable future.





Distribution,
Sales and Customers





Our
objective is to become a leader in the development and commercialization of
advanced proprietary diagnostic products with the capability to differentiate in
real-time between healthy, and pre-cancerous or cancerous tissue. During 2009,
our sales and marketing efforts will be focused on selling, leasing or renting
the WavSTAT and LUMA Systems in the colorectal, cervical and esophageal cancer
diagnostic markets. We envision particular emphasis on selling the WavSTAT
System in international markets.





In the
United States, successful product introduction will require a larger direct
sales force or a strategic corporate partner that has strongly established call
patterns within Managed Care Organizations. Management believes the availability
of clinical support specialists to support the sales force, and to conduct
training seminars to educate endoscopists and other health care providers
regarding proper use of the WavSTAT and LUMA Systems, will be a strong component
of a product introduction strategy. To further these objectives during 2008, the
Company hired a new Director of Marketing and Sales, a Director of International
Sales and appointed new European Distributors.


9


SpectraScience
may seek a strategic partner or alliance to further develop and implement
product introduction, marketing and sales capabilities. Management would focus
on partners with large sales forces and established call patterns within Managed
Care organizations. Management believes that use of distributors in its
international target markets is appropriate. The distributors should have
significant resources and strong franchises which, when coupled with our
technology, will increase the likelihood of commercial success in those
markets.





Third-Party
Reimbursement





We expect
to market and sell the WavSTAT and LUMA Systems primarily through hospitals and
clinics. In the United States, the purchasers of medical devices generally rely
on Medicare, Medicaid, private health insurance plans, health maintenance
organizations and other sources of third party reimbursement for health care
costs, to reimburse all or part of the cost of medical devices and/or the
procedure in which the medical device is used. Significant sales of the our
Systemswill,
in part, be dependent on the availability of adequate reimbursement from these
third party payers for procedures carried out using our products. We believe
that less invasive procedures generally provide less costly overall therapies
compared to conventional drugs, surgery and other treatments. We anticipate
hospital administrators and physicians will justify the use of our products by
the cost and timesaving recognized and clinical benefits that we believe will be
derived from the use of our products.





Third
party payers determine whether to provide coverage for a particular procedure
and reimburse health care providers for medical treatment at a fixed rate based
on the diagnosis-related group established by the Center for Medicare and
Medicaid Services (“CMS”). The fixed rate of reimbursement is based on the
procedure performed and is unrelated to the specific type or number of devices
used in a procedure. If a procedure is not covered by a diagnosis-related group,
payers may deny reimbursement. If reimbursement for a particular procedure is
approved, third party payers will reimburse health care providers for medical
treatment based on a variety of methods, including a lump sum prospective
payment system based on a diagnosis-related group or per diem, a blend between
the health care provider’s reported costs and a fee schedule, a payment for all
or a portion of charges deemed reasonable and customary, or a negotiated per
capita fixed payment.





Upon
product introduction, currently existing available codes can be used to provide
a level of reimbursement to users. Management believes however, that currently
available reimbursement codes do not adequately reimburse for the anticipated
value that optical biopsy technology brings to the medical care system. Optical
biopsies are not currently approved for reimbursement by third-party payers, and
there can be no assurance that optical biopsy technology will be approved for
any third party reimbursement, even if it proves to play a significant role in
improving the endoscopist’s ability to accurately differentiate among polyps in
the colon, Barrett’s esophagus or cervical dysplasia, thereby leading to early
detection and subsequent treatment.





Medical
equipment capital costs incurred by hospitals are reimbursed separately from
diagnosis-related group payments. Changes in federal legislation, or policies of
the government or third-party payers that reduce reimbursements under capital
cost pass through-systems, could adversely affect the market for our
products.





As stated
previously, demonstrating cost-effectiveness and improved patient outcomes is
critical to the sales cycle since payers evaluate these factors in determining
whether to reimburse for new technologies. Payers may also delay reimbursement
decisions for a year or more, even when provided with cost-effectiveness data,
while they conduct their own technology assessments. The availability of
peer-reviewed literature regarding the technology may help payers in reducing
this technology assessment timeline. To promote the dissemination of literature
regarding the WavSTAT, LUMA and optical biopsy technology, SpectraScience
intends to have published clinical utility data in peer-reviewed
journals.





We expect
that there will be continued pressure on cost-containment throughout the United
States health care system. Cost reduction, cost containment, managed care, and
capitation pricing (putting a ceiling on the price) are very familiar themes
within healthcare. Limits on third-party reimbursements that lead to cuts in
reimbursements for new or experimental procedures would affect the ability of
smaller companies with new technologies, to compete with larger established
firms, or with established technologies. Lobbying activities are often necessary
to bring to light the value of these new technologies but require extensive
amounts of corporate resources that the Company may not be able to
afford.





Reimbursement
systems in international markets vary significantly by country and by region
within some countries, and reimbursement approvals must be obtained on a
country-by-country basis. Many international markets have government managed
health care systems that control reimbursement for new products and procedures.
In most markets, there are private insurance systems as well as government
managed systems. Market acceptance of the SpectraScience products will depend on
the availability and level of reimbursement in international markets we target.
There can be no assurance that we will obtain reimbursement in any country
within a particular time, for a particular time, for a particular amount, or at
all.





We are
unable to predict what additional legislation or regulation relating to the
health care industry or third-party coverage and reimbursement may be enacted in
the future, if any, or what effect it might have on us. Reforms may include (i)
mandated basic health care benefits, (ii) controls on health care spending
through limitations on the growth of private health insurance premiums and
Medicare and Medicaid spending, (iii) greater reliance on prospective payment
systems, (iv) the creation of large insurance purchasing groups, and (v)
fundamental changes to the health care delivery system. Management anticipates
that Congress and state legislatures will continue to review and assess
alternative health care delivery systems and payment mechanisms. Due to
uncertainties regarding the ultimate features of reform initiatives and their
enactment and implementation, we cannot predict which reform proposals, if any,
will be adopted, when they may be adopted or what impact they may have on
SpectraScience. Failure by hospitals and other users of our products to obtain
reimbursement from third-party payers, or changes in government and private
third-party payers’ policies toward reimbursement for procedures employing our
products, could have a material adverse effect on our business, financial
condition and results of operations.


10




Manufacturing
and Sources of Supply





SpectraScience
manufactures the WavSTAT and LUMA Systems at its facility in San Diego. The
WavSTAT forceps are outsourced to United States contract OEM manufacturers. At
the present time, SpectraScience performs the manufacturing of the optical fiber
portion of the forceps in-house. The Company also performs certain final
assembly processes of the WavSTAT Forceps. All WavSTAT and LUMA Systems
previously used for pre-clinical testing, FDA compliant clinical trials, and
cost effectiveness/outcome clinical studies were manufactured under a Quality
System with Standard Operating Procedure controls. Management continues to
utilize these quality control Systems and adds to or modifies them as
necessary.





The
WavSTAT and LUMA Systems are, and will be, manufactured in accordance with
current FDA Quality System Regulations (“QSR”) and ISO 9001 International
Standards, both of which are necessary to sell products within the United States
and the European Union. These requirements impose certain procedural and
documentation requirements upon SpectraScience with respect to manufacturing and
quality assurance activities, as well as upon those third parties with whom the
Company contracts to perform certain manufacturing processes.





During
the third quarter of 2007, SpectraScience was granted ISO 9001 and 13485:2003
certification for its manufacturing facility and Quality System. These
international standards are the European equivalent to the FDA’s Quality System
Regulations. Meeting these standards permits use of the “CE mark” to export the
WavSTAT optical biopsy system to the European Union and most other countries of
the world.





The
manufacturing processes and Standard Operating Procedures required to build a
WavSTAT and LUMA System have been reviewed by the FDA and we are authorized to
manufacture the product in our current facility.   Both the FDA
and the European Notified Body will continue to perform periodic audits as long
as SpectraScience manufactures and commercializes medical products





Competition





The
medical device industry is highly competitive. Management believes the Company
has few direct competitors in applying spectroscopy for the differentiation of
normal, pre-cancerous or cancerous tissues in the gastrointestinal tract;
however, the development of products using spectroscopic diagnostics for various
medical specialties is rapidly growing. To the best of our knowledge, no other
competitors have completed FDA clinical studies or submitted a pre-market
approval application to the FDA or received CE Mark authority to distribute a
product for the detection of colorectal or esophageal cancer.





The
companies listed below have developed or are in the process of developing
products that use light-based spectroscopic technology. They could potentially
compete with SpectraScience products or technologies. Although none of these
companies uses a technology or method which is the same as the SpectraScience
technologies and methods.




·
            Mediscience
      Technology (Cherry Hill, New Jersey-OTC:MDSC.OB) has conducted feasibility
      clinical studies for oral leukopakia, a pre-cancerous condition of the
      mouth, with a prototype product called CD SCAN which uses a light-based
      spectroscopy system. They plan to conduct clinical studies in the areas of
      cervical cancer with products using spectroscopic
    technology.




·
            Electro-Optical
      Sciences, Inc. (Irvington, NY-OTC:MELA) is focused on the design and
      development of a non-invasive, point-of-care instrument to assist in the
      early diagnosis of melanoma. MelaFind® features a hand-held imaging device
      that emits multiple wavelengths of light to capture images of suspicious
      pigmented skin lesions and extract data. The data is then analyzed against
      its proprietary database of melanomas and benign lesions using
      sophisticated algorithms in order to provide information to the physician
      and produce a recommendation of whether the lesion should be biopsied.
      They are currently designing clinical
trials.





·
            Guided
      Therapeutics, Inc.(Norcross, GA-OTC GTHP) is a medical technology company
      focused on developing medical devices that have the potential to improve
      health care. The technology, including products in research and
      development, includes: a) biophotonics technology for the non-invasive
      detection of cancers, including cervical cancer, b) methods of sampling
      interstitial fluid using laser energy to create micropores for improved
      glucose and alcohol monitoring and c) methods of delivering insulin to
      people with diabetes with a SimpleChoice® product line. In 2007, they
      indicated that they sold their insulin delivery business and will focus on
      completing the development of their cervical cancer detection
      device.


11





·
            STI
      Medical Systems – (Honolulu, HI) is developing what they call
      Hyperspectral Diagnostic Imaging (HSDI®) for use in detecting cervical
      cancer and other cancers. HSDI is claimed to be a unique, high-tech blend
      of spectral and spatial imaging and image processing, exploiting
      biochemical phenomenology to address unmet diagnostic needs. HSDI utilizes
      Virtual Biopsy® technology to automatically capture and analyze data using
      a combination of high-resolution digital imagery, tissue fluorescence
      imagery and white-light reflectance imagery. Advanced computer aided
      diagnosis algorithms use these data to detect, classify and localize
      cancer and cancerous tissue with accurate delineation of disease margins.
      It is unknown if the company has tested the product on patients with
      sufficient volume to make an FDA
filing.





Many of
these companies have substantially greater resources than we do, either
internally or in combination with strategic partners. These resources may allow
them to develop, market and distribute technologies or products that could be
more effective than those developed or marketed by us, or that would render our
technologies and products obsolete. The resource advantages they may have
are:





·
            greater
      capital resources,·
            greater
      manufacturing resources,·
            greater
      resources and expertise in testing products in clinical
      trials,·
            greater
      resources and expertise in the areas of research and
      development,·
            greater
      expertise in obtaining regulatory approvals, and·
            greater
      resources for marketing and sales
activities.





Patents





SpectraScience
currently owns exclusive rights to a total of eight issued US patents and
international patents for the WavSTAT technology.





Patent
      Name
                    
                    U.S. Patent
                      NumberOptical
      Biopsy Forceps
                    
                    
                    5,762,613System
      for Diagnosing Tissue with Guidewire
                    
                    
                    5,601,087Method
      of Diagnosing Tissue with Guidewire
                    
                    
                    5,439,000Guidewire
      Catheter and Apparatus for Diagnostic Imaging
                    
                    
                    5,383,467Optical
      Biopsy Forceps System and Method of Diagnosing Tissue
                    
                    
                    6,066,102Optical
      Biopsy Forceps
                    
                    
                    6,129,683Optical
      Biopsy System and Methods for tissue Diagnosis
                    
                    
                    6,174,291Optical
      Forceps System and Method of Diagnosing and Treating
Tissue
                    
                    
                    6,394,964




SpectraScience
is also the exclusive licensee through the Massachusetts General Hospital of US
Patent 5,843,000 entitled, “Optical Biopsy Forceps and Method of Diagnosing
Tissue” and a pending international patent application. The above patents expire
between January 2015 and May 2022. Each of the international patents designates
several countries for patent protection.





SpectraScience
currently owns exclusive rights to a total of thirty-four issued US patents and
international patents for the LUMA technology.


12





Patent
      Name
                        
                        U.S. Patent
                          NumberSpectral
      Volume Microprobe Analysis of Materials
                        
                        
                        5,713,364Spectral
      Volume Microprobe Arrays
                        
                        
                        6,104,945Sheath
      for Cervical Optical Probe
                        
                        
                        D453,832Sheath
      for Cervical Optical Probe
                        
                        
                        D453,962Sheath
      for Cervical Optical Probe
                        
                        
                        D453,963Sheath
      for Cervical Optical Probe
                        
                        
                        D456,964Spectroscopic
      System Employing a Plurality of Data Types
                        
                        
                        6,385,484Spectral
      Volume Microprobe Arrays
                        
                        
                        6,411,835Systems
      and Methods for Optical Examination of Samples
                        
                        
                        6,411,838Spectral
      Data Classification of Samples
                        
                        
                        6,421,553Optical
      Methods and Systems for Rapid Screening of the Cervix
                        
                        
                        6,427,082Sheath
      for Cervical Optical Probe
                        
                        
                        D460,821Substantially
      Monostatic, Substantially Confocal Optical Systems for Examination of
      Samples
                        
                        
                        6,760,613Fluorescent
      Fiberoptic Probe for Tissue Health Discrimination and Method of Use
      Thereof
                        
                        
                        6,768,918Method
      and Apparatus for Identifying Spectral Artifacts
                        
                        
                        6,818,903Spectral
      Volume for Microprobe Arrays
                        
                        
                        6,826,422Sheath
      for Cervical Optical Probe
                        
                        
                        D507,349System
      for Normalizing Spectra
                        
                        
                        6,839,661Optical
      Probe Accessory Device for Use In-Vivo Diagnostic
    Procedures
                        
                        
                        6,847,490Methods
      of Monitoring Effects of Chemical Agents on a Sample
                        
                        
                        6,902,935Sheath
      for Cervical Optical Probe
                        
                        
                        D500,134Optimal
      Windows for Obtaining Optical Data for Characterization of Tissue
      Samples
                        
                        
                        6,933,154Methods
      and Apparatus for Displaying Diagnostic Data
                        
                        
                        7,136,518Spectral
      Volume Microprobe Analysis of Materials
                        
                        
                        5,813,987Colonic
      Polyp Discrimination by Tissue Florescence and Fiberoptic
      Probe
                        
                        
                        7,103,401Optical
      Methods and Systems for Rapid Screening of the Cervix
                        
                        
                        7,127,282Methods
      and Systems for Correcting Image Misalignment
                        
                        
                        7,187,810Image
      Processing using Measures of Similarity
                        
                        
                        7,260,248Methods
      and Apparatus for Processing Spectral Data for use in Tissue
      Characterization
                        
                        
                        7,282,723Methods
      and apparatus for characterization of tissue samples
                        
                        
                        7,309,867Fluorescent
      fiberoptic probe for tissue health discrimination
                        
                        
                        7,310,547Methods
      and Systems for Correcting Image Misalignment
                        
                        
                        7,406,215Unique
      Methods of Calibrating Spectral Data
                        
                        
                        7,459,696Unique
      Methods and Apparatus for Evaluation of Image Focus
                        
                        
                        7,469,160




An
additional 18 patent applications are pending. In total, more than 500 valid
claims have been granted covering a broad range of technology and methods.
Foreign rights have further been secured for many of the most important
patents.





SpectraScience
believes that it holds the single largest patent portfolio of its kind in the
field of optical methods for identifying tissue abnormalities, particularly for
identifying cancer and its precursors. The Company also believes that its
portfolio will protect the core technology and methods embodied in the LUMA and
WavSTAT Systems and for many of its foreseeable product extensions and will
create a substantial barrier to entry for others pursuing similar
approaches.





Core
Areas of Patent Protection




More
specifically, SpectraScience’s portfolio provides protection in the following
key technology, design and methods areas:




s
            Localized
      tissue characterization using optical
methods




s
            Specific
      application of fluorescence and broadband spectroscopy, and video imaging,
      particularly in combination




s
            Designs
      and use of a disposable sheath, particularly in combination with systems
      and methods, including use of unique
identifiers




s
            Algorithmic
      methods specific to optical assessment of tissue characteristics,
      particularly involving identification, classification and calibration
      methods




s
            Clinical
      applications of these methods and systems for identifying tissue
      characteristics, including use of display methods, marking methods
      (including biomarkers), and in combination with
  treatment




s
            Applications
      to further system development, including applications for screening,
      treatment and other fields beyond cervical
  cancer





SpectraScience
holds registered trademarks for the WavSTAT and LUMA Cervical Imaging System and
SpectraScience documents, software and graphics are protected by appropriate
copyrights.


13


SpectraScience’s
ability to obtain and maintain patent protection for its products, preserve its
trade secrets and operate without infringing on the proprietary rights of others
will directly affect the success the Company's operations. The Company's
strategy regarding the protection of its proprietary intellectual property and
innovations is to seek patents on those portions of our technology that
management believes are patentable, to obtain copyrights for its software if
appropriate, and to protect as trade secrets other confidential information and
proprietary know-how. There are certain technological aspects of the WavSTAT and
LUMA Systems that are not covered by any patents or patent applications.
SpectraScience seeks to protect its trade secrets and proprietary know-how by
obtaining confidentiality and invention assignment agreements in connection with
employment, consulting and advisory relationships.




Our
ability to obtain and maintain patent protection for our products, preserve our
trade secrets and operate without infringing on the proprietary rights of others
will directly affect how successful our operations will be. Our strategy
regarding the protection of our proprietary rights and innovations is to seek
patents on those portions of our technology that we believe are patentable, and
to protect as trade secrets other confidential information and proprietary
know-how.





The
patent and trade secret positions of medical device companies like
SpectraScience are uncertain and involve complex and evolving legal and factual
questions. To date, no claims have been brought against SpectraScience alleging
that our technology or products infringe intellectual property rights of others.
Often, patent and intellectual property disputes in the medical device industry
are settled through licensing or similar arrangements. However, there can be no
assurance that necessary licenses from other parties would be available to us on
satisfactory terms, if at all. The costs associated with such arrangements may
be substantial and could include ongoing royalties.





United
States patent applications are secret until patents are issued or corresponding
foreign applications are published in other countries. Since publication of
discoveries in the scientific or patent literature often lags behind actual
discoveries, management cannot be certain that SpectraScience was the first to
invent the inventions covered by each of its pending patent applications, or
that it was the first to file patent applications for such inventions. In
addition, the laws of some foreign countries do not provide the same degree of
intellectual property right protection as do the laws of the United States.
Litigation associated with patent or intellectual property infringement or
protection can be lengthy and prohibitively costly. There can be no assurance
that SpectraScience would have the financial resources to defend its patents
from infringement or claims of invalidity, or to successfully defend itself
against intellectual property infringement claims by third parties.





Product
Liability





The risk
of product liability claims, product recalls and associated adverse publicity is
inherent in the testing, manufacturing, marketing and sale of medical products.
We have clinical trial liability insurance coverage at this time for our
clinical programs. There can be no assurance that future insurance coverage will
be adequate or available. We may not be able to secure product liability
insurance coverage on acceptable terms or at reasonable costs when needed. Any
liability damages could exceed the amount of our coverage. A successful product
liability claim against us could require us to pay a substantial monetary award.
Moreover, a product recall could generate substantial negative publicity about
our products and business and inhibit or prevent commercialization of other
future products.





Employees





As of
March 25, 2009, SpectraScience had ten full-time employees, six involved with
manufacturing, two in sales and marketing and two engaged in finance and
administration. The Company’s payroll is administered through an independent
third party. SpectraScience is not subject to any collective bargaining
agreement and management believes that employee relations are generally
satisfactory.





SpectraScience
relies on external consultants in the financial, regulatory, software
development and design engineering areas. When management determines to increase
our workforce in response to improved economic, market, and/or business
conditions, there is no assurance that we will be able to attract or retain
employees with the skills we require.





Executive
Officers and Additional Individuals





Name
                  
                  Age
                  
                  PositionJim
      Hitchin
                  
                  66
                  
                  Chairman,
      President and Chief Executive OfficerJames
      Dorst
                  
                  54
                  
                  VP
      Finance and Chief Financial OfficerTodd
      Pinkowski
                  
                  46
                  
                  Director
      of OperationsMichel
      Vaudry
                  
                  64
                  
                  Director
      of International
Sales





The
following biographical information was provided by the respective officers and
individuals.


14


Jim Hitchin, Chairman, President and
CEO joined SpectraScience in January 2004 as part of the bankruptcy
acquisition team. For the previous 15 years, he was the founder, CEO and
Chairman of Infrasonics, Inc., a medical device company in the respiratory care
field. Infrasonics was venture funded and completed a successful initial public
offering. Mr. Hitchin served as Chairman, President and CEO of Infrasonics
during its 15 years as a public company. Infrasonics was the first in its market
to have ISO 9001 and the CE Mark for fourteen 510(k) and two PMA products.
Infrasonics revenue growth was at a compound rate of 62% during its fifteen-year
life before being sold to a competitor for 2.5 times revenue. In previous
companies, he was COO of a public energy company and the VP, General Manager of
a public oceanographic engineering firm. Mr. Hitchin has extensive experience in
all phases of manufacturing and company operations, in particular, sales and
marketing of medical devices. He graduated from San Diego State University with
a degree in Physics.





Jim Dorst, Vice President of Finance
and CFO joined the Company in December 2007. Mr. Dorst brings to the
Company over 20 years of senior management experience in finance, operations,
planning and business transactions. Prior to joining SpectraScience, Mr. Dorst
was Chief Financial Officer of Aethlon Medical, Inc., a public medical device
development company. Before joining Aethlon, Mr. Dorst was Vice President of
Finance and Operations for Verdisoft Corporation, a developmental-stage
mobile-software developer acquired by Yahoo, Inc. Previously, he held executive
positions as SVP of Finance and Administration at SeeCommerce, COO/CFO of Omnis
Technology Corp and CFO / SVP of Information Technology at Savoir Technology
Group, Inc. (acquired by Avnet, Inc.). Mr. Dorst practiced as a Certified Public
Accountant with Coopers & Lybrand (PricewaterhouseCoopers) and holds an MS
in Accounting and a BS in Finance from the University of Oregon.





Todd Pinkowski, Director of
Operations,joined the Company in December 2007. From 1998 to 2007 he
held the position of Senior Manager of Technical Service & Manufacturing at
ResMed Corp. Prior to this, he worked for 14 years as a senior production
supervisor at Infrasonics/Nellcor PB. He began his professional career as a
Sergeant, Armament Systems Specialist, in the US Air Force after having
graduated from high school in Valatie, N.Y.




Michel G. Vaudry, Director of
International Sales,joined the Company in July 2004. He previously held
the position of Technical Director at Hemotherapies, Inc., a Liver Dialysis
manufacturer. Prior to Hemotherapies, he was the President of Medicare
Industries, Inc., manufacturing Intensive Care equipment for neonates. At
Medicare Industries, he also headed the Operations and Regulatory/Quality
control Departments and set-up International manufacturing and
research/development alliances. He was responsible for establishing ISO 9001 and
CE marks for two companies. Previously, he moved from Europe to the US and held
the position of VP International Sales for a major medical device manufacturer.
Mr. Vaudry has a Bachelor of Science in Electronic Engineering and a Degree in
Mechanical Engineering from the University of Caen, Normandy, France. He is
fluent in French, English and conversational in Spanish and has some knowledge
of spoken Arabic.





ITEM 1A.
RISK FACTORS.





We have
described below a number of uncertainties and risks which, in addition to
uncertainties and risks presented elsewhere in this annual report may adversely
affect our business, operating results and financial condition. The
uncertainties and risks enumerated below as well as those presented elsewhere in
this annual report should be considered carefully in evaluating our company and
our business and the value of our securities.





WE HAVE A
LIMITED OPERATING HISTORY WITH SIGNIFICANT LOSSES AND EXPECT LOSSES TO CONTINUE
FOR THE FORESEEABLE FUTURE





We have
yet to establish any history of profitable operations. We have incurred annual
operating losses of $5,271,332 and $3,020,588, respectively, during the past two
years of operations. As a result, at December 31, 2008 we had an accumulated
deficit of $11,720,273. We have incurred net losses from continuing operations
of $5,144,902 and $2,974,585 for the fiscal years ending 2008 and 2007. Our
revenues have not been sufficient to sustain our operations and we expect that
they will be insufficient to sustain our operations for the foreseeable future.
Our failure to generate meaningful revenues and ultimately profits from the
WavSTAT and LUMA Systems and applications of our technology could force us to
raise additional capital which may not be available or available on acceptable
terms. This could ultimately reduce or suspend our operations and ultimately
cause us to go out of business. Our profitability will require the successful
commercialization of our imaging systems and no assurances can be given when
this will occur or if we will ever be profitable.





WE WILL
REQUIRE ADDITIONAL FINANCING TO SUSTAIN OUR OPERATIONS AND WITHOUT IT, WE MAY
NOT BE ABLE TO CONTINUE OPERATIONS.




At
December 31, 2008, we had a working capital balance of $1,759,440. We had an
operating cash flow deficit of $3,811,212 for the fiscal year ended December 31,
2008 and an operating cash flow deficit of $1,459,811 in 2007. We do not have
sufficient financial resources to fund our operations. Therefore, we will likely
need additional funds to continue our operations.




We will
need additional capital to fully implement our business, operating and
development plans. Should the financing we require to sustain our working
capital needs be unavailable or prohibitively expensive when we require it, the
consequences would be a material adverse effect on our business, financial
condition, results of operations and cash flows.


15


WE HAVE
RECEIVED AN OPINION FROM OUR AUDITORS REGARDING OUR ABILITY TO CONTINUE AS A
GOING CONCERN.





Our
independent auditors noted in their report accompanying our financial statements
for our fiscal year ended December 31, 2008 that we have incurred losses and had
negative cash flows from inception and that additional capital will be necessary
to market our products to finance our operations, but there is no assurance that
such financing will be available, and stated that those conditions raised
substantial doubt about our ability to continue as a going concern. We cannot
assure you that our business plans will be successful. This opinion about our
ability to continue as a going concern could affect our ability to obtain
additional financing at favorable terms, if at all; as such an opinion could
cause investors to lose faith in our long term prospects. If we cannot
successfully continue as a going concern, our shareholders could lose their
entire investment in our common shares.





WE MAY
FACE INTENSE COMPETITION FROM COMPANIES THAT HAVE GREATER FINANCIAL, PERSONNEL
AND RESEARCH AND DEVELOPMENT RESOURCES.





These
competitive forces may impact our projected growth and ability to generate
revenues and profits, which would have a negative impact on our business and the
value of your investment. Our competitors may be developing products which
compete with the WavSTAT and LUMA Systems. Our commercial opportunities would
then be reduced or eliminated should our competitors develop and market products
for any of the diseases that we target that;





·
            Are
      more effective;





·
            Are
      less expensive than the products or product candidates we are
      developing.





Even if
we are successful in developing effective WavSTAT and LUMA Systems, and we
obtain FDA and other regulatory approvals necessary for commercializing them,
our products may not compete effectively with other successful products.
Researchers are continually learning more about diseases, which may lead to new
technologies and tools for analysis. Our competitors may succeed in developing
and marketing products either that are more effective than those that we may
develop, alone or with our collaborators, that are marketed before any products
we develop are brought to market, or that are as effective but less costly than
our products.





Our
competitors include fully integrated medical device companies, universities and
public and private research institutions. Many of the organizations competing
with us, have substantially greater capital resources, larger research and
development staffs and facilities, greater experience in product development and
in obtaining regulatory approvals, and greater marketing capabilities than we
do.





The
market for medical devices is intensely competitive. Many of our potential
competitors have longer operating histories, greater name recognition, more
employees, and significantly greater financial, technical, marketing, public
relations, and distribution resources than we have. This intense competitive
environment may require us to make changes in our products, pricing, licensing,
services or marketing to develop, maintain and extend our current technology.
Price concessions or the emergence of other pricing or distribution strategies
of competitors may diminish our revenues, adversely impact our margins or lead
to a reduction in our market share, any of which may harm our
business.




OUR
WavSTAT AND LUMA SYSTEMS TECHNOLOGY MAY BECOME OBSOLETE.





Our
WavSTAT and LUMA Systems products may be made unmarketable by new scientific or
technological developments where new treatment modalities are introduced that
are more efficacious or more economical than our WavSTAT and LUMA System
products. Any one of our competitors could develop a more effective product
which would render our technology obsolete.




WE ARE
DEPENDENT FOR OUR SUCCESS ON A KEY EXECUTIVE OFFICER.





Our
success depends to a critical extent on the continued services of our Chief
Executive Officer, Jim Hitchin. If we lost this key executive officer, we would
be forced to expend significant time and money in the pursuit of a replacement,
which would result in both a delay in the implementation of our business plan
and the diversion of limited working capital. We can give you no assurance that
we could find a satisfactory replacement for this key executive officer at all,
or on terms that are not unduly expensive or burdensome. We do not have an
employment agreement with Mr. Hitchin and his employment is severable by either
party at will. We currently carry a key man life insurance policy on him in the
amount of $2,000,000.





OUR
INABILITY TO ATTRACT AND RETAIN QUALIFIED PERSONNEL COULD IMPEDE OUR ABILITY TO
GENERATE REVENUES AND PROFITS AND TO OTHERWISE IMPLEMENT OUR BUSINESS PLAN AND
GROWTH STRATEGIES, WHICH WOULD HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND COULD
ADVERSELY AFFECT THE VALUE OF YOUR INVESTMENT.


16


We
currently have a staff of ten full time employees, consisting of, among others,
our Chief Executive Officer, Chief Financial Officer, Director of Sales and
Marketing, Operations Manager, a Chief Engineer, Director of Regulatory Affairs
and an Export Sales Manager as well as administrative employees other personnel
employed on a contract basis. Although we believe that these employees, together
with the consultants currently engaged by the Company, will be able to handle
most of our additional administrative, research and development and business
development in the near term, we will nevertheless be required over the
longer-term to hire highly skilled managerial, scientific and administrative
personnel to fully implement our business plan and growth strategies. We cannot
assure you that we will be able to engage the services of such qualified
personnel at competitive prices or at all, particularly given the risks of
employment attributable to our limited financial resources and lack of an
established track record.





WE PLAN
TO GROW VERY RAPIDLY, WHICH WILL PLACE STRAINS ON OUR MANAGEMENT TEAM AND OTHER
COMPANY RESOURCES TO BOTH IMPLEMENT MORE SOPHISTICATED MANAGERIAL, OPERATIONAL
AND FINANCIAL SYSTEMS, PROCEDURES AND CONTROLS AND TO TRAIN AND MANAGE THE
PERSONNEL NECESSARY TO IMPLEMENT THOSE FUNCTIONS. OUR INABILITY TO MANAGE OUR
GROWTH COULD IMPEDE OUR ABILITY TO GENERATE REVENUES AND PROFITS AND TO
OTHERWISE IMPLEMENT OUR BUSINESS PLAN AND GROWTH STRATEGIES, WHICH WOULD HAVE A
NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR INVESTMENT.





We will
need to significantly expand our operations to implement our longer-term
business plan and growth strategies. We will also be required to manage multiple
relationships with various strategic partners, technology licensors, customers,
manufacturers and suppliers, consultants and other third parties. This expansion
and these expanded relationships will require us to significantly improve or
replace our existing managerial, operational and financial systems, procedures
and controls; to improve the coordination between our various corporate
functions; and to manage, train, motivate and maintain a growing employee base.
The time and costs to effectuate these steps may place a significant strain on
our management personnel, systems and resources, particularly given the limited
amount of financial resources and skilled employees that may be available at the
time. We cannot assure you that we will institute, in a timely manner or at all,
the improvements to our managerial, operational and financial systems,
procedures and controls necessary to support our anticipated increased levels of
operations and to coordinate our various corporate functions, or that we will be
able to properly manage, train, motivate and retain the anticipated increased
number of employees.




THE
COMPANY MAY HAVE DIFFICULTY IN DEVELOPING AND RETAINING AN EFFECTIVE SALES FORCE
OR IN OBTAINING EFFECTIVE DISTRIBUTION PARTNERS AND MAY NOT BE ABLE TO ACHIEVE
SUFFICIENT REVENUES TO EFFECT ITS BUSINESS PLAN





The
market for skilled sales and marketing personnel is highly competitive and
specialized. If we are unable to hire and retain skilled and knowledgeable sales
people it may negatively impact our ability to introduce our products or
generate revenue sufficient to affect our future business plans. In addition,
our inability to develop business relationships with key technical distributors
may also negatively impact our ability to successfully market our
products.





THE
COMPANY MAY BE UNSUCCESSFUL IN COMMERCIALIZING THE LUMA ASSETS





With the
successful acquisition of the LUMA Imaging Corp. assets in November of 2007, we
will have to manage its assets, primarily intellectual property, to successfully
commercialize the LUMA products. Our limited number of technical and marketing
personnel, and our limited budget, may be inadequate for the task.





WE MAY
HAVE DIFFICULTY IN ATTRACTING AND RETAINING MANAGEMENT AND OUTSIDE INDEPENDENT
MEMBERS TO OUR BOARD OF DIRECTORS AS A RESULT OF THEIR CONCERNS RELATING TO
THEIR INCREASED PERSONAL EXPOSURE TO LAWSUITS AND STOCKHOLDER CLAIMS BY VIRTUE
OF HOLDING THESE POSITIONS IN A PUBLICLY-HELD COMPANY.





The
directors and management of publicly traded corporations are increasingly
concerned with the extent of their personal exposure to lawsuits and stockholder
claims, as well as governmental and creditor claims which may be made against
them, particularly in view of recent changes in securities laws imposing
additional duties, obligations and liabilities on management and directors. Due
to these perceived risks, directors and management are also becoming
increasingly concerned with the availability of directors and officers liability
insurance to pay on a timely basis the costs incurred in defending such claims.
We currently carry directors’ and officers’ liability insurance, but such
insurance is expensive and can be difficult to obtain. If we are unable to
obtain directors and officers liability insurance at affordable rates or at all
in the future, it may become increasingly more difficult to attract and retain
qualified outside directors to serve on our board of directors. The fees of
directors are also rising in response to their increased duties, obligations and
liabilities as well as increased exposure to such risks. As a company with a
limited operating history and limited resources, we will have a more difficult
time attracting and retaining management and outside independent directors than
a more established company due to these enhanced duties, obligations and
liabilities.


17


IF WE
FAIL TO COMPLY WITH EXTENSIVE REGULATIONS ENFORCED BY DOMESTIC AND FOREIGN
REGULATORY AUTHORITIES, THE COMMERCIALIZATION OF OUR PRODUCTS COULD BE PREVENTED
OR DELAYED.





Our
WavSTAT and LUMA Systems are subject to extensive government regulations related
to development, testing, manufacturing and commercialization in the United
States and other countries. The determination of when and whether a product is
ready for large scale purchase and potential use will be made by the government
through consultation with a number of governmental agencies, including the FDA,
the National Institutes of Health, and the Centers for Disease Control and
Prevention. Some of our product candidates are in the clinical stages of
development and have not received required regulatory approval from the FDA for
the esophageal or lung applications we hope to commercially market. The process
of obtaining and complying with FDA and other governmental regulatory approvals
and regulations is costly, time consuming, uncertain and subject to
unanticipated delays. Despite the time and expense incurred, regulatory approval
is never guaranteed. We also are subject to the following risks and obligations,
among others.




·
            The
      FDA may refuse to approve an application if they believe that applicable
      regulatory criteria are not
satisfied





·
            The
      FDA may require additional testing for safety and
      effectiveness





·
            The
      FDA may interpret data from pre-clinical testing and clinical trials in
      different ways than we interpret
them





·
            If
      regulatory approval of a product is granted, the approval may be limited
      to specific indications or limited with respect to its
      distribution





·
            The
      FDA may change their approval policies and/or adopt new
      regulations





Failure
to comply with these or other regulatory requirements of the FDA may subject us
to administrative or judicially imposed sanctions, including:





·
            warning
      letters·
            civil
      penalties·
            criminal
      penalties·
            Injunctions·
            product
      seizure or detention·
            product
      recalls·
            total
      or partial suspension of production





DELAYS IN
SUCCESSFULLY COMPLETING OUR CLINICAL TRIALS COULD JEOPARDIZE OUR ABILITY TO
OBTAIN REGULATORY APPROVAL OR MARKET OUR WavSTAT AND LUMA SYSTEM CANDIDATES ON A
TIMELY BASIS.





Our
business prospects will depend on our ability to complete clinical trials,
obtain satisfactory results, obtain required regulatory approvals and
successfully commercialize our WavSTAT and LUMA System product candidates.
Completion of our clinical trials, announcement of results of the trials and our
ability to obtain regulatory approvals could be delayed for a variety of
reasons, including:





·
            Unsatisfactory
      results of any clinical trial





·
            The
      failure of our principal third-party investigators to perform our clinical
      trials on our anticipated schedules





·
            Different
      interpretations of our pre-clinical and clinical data, which could
      initially lead to inconclusive
results





OUR
DEVELOPMENT COSTS WILL INCREASE IF WE HAVE MATERIAL DELAYS IN ANY CLINICAL TRIAL
OR IF WE NEED TO PERFORM MORE OR LARGER CLINICAL TRIALS THAN
PLANNED.


18


If the
delays are significant, or if any of our WavSTAT System or LUMA product
candidates do not prove to be safe or effective or do not receive required
regulatory approvals, our financial results and the commercial prospects for our
product candidates will be harmed. Furthermore, our inability to complete our
clinical trials in a timely manner could jeopardize our ability to obtain
regulatory approval.





THE
INDEPENDENT CLINICAL INVESTIGATORS THAT WE RELY UPON TO CONDUCT OUR CLINICAL
TRIALS MAY NOT BE DILIGENT, CAREFUL OR TIMELY, AND MAY MAKE MISTAKES, IN THE
CONDUCT OF OUR CLINICAL TRIALS.





We depend
on independent clinical investigators to conduct our clinical trials. The
investigators are not our employees, and we cannot control the amount or timing
of resources that they devote to our product development programs. If
independent investigators fail to devote sufficient time and resources to our
product development programs, or if their performance is substandard, it may
delay FDA approval of our products. These independent investigators may also
have relationships with other commercial entities, some of which may compete
with us. If these independent investigators assist our competitors at our
expense, it could harm our competitive position.





OUR
PRODUCT DEVELOPMENT EFFORTS MAY NOT YIELD MARKETABLE PRODUCTS DUE TO RESULTS OF
STUDIES OR TRIALS, FAILURE TO ACHIEVE REGULATORY APPROVALS OR MARKET ACCEPTANCE,
PROPRIETARY RIGHTS OF OTHERS OR MANUFACTURING ISSUES.





Our
success depends on our ability to successfully develop and obtain regulatory
approval to market new products. We expect that a significant portion of the
research that we will conduct will involve new and unproven technologies.
Development of a product requires substantial technical, financial and human
resources even if the product is not successfully completed.





Our
potential products may appear to be promising at various stages of development
yet fail to reach the market for a number of reasons, including
the:





·
            Lack
      of adequate quality or sufficient prevention benefit, or unacceptable
      safety during pre-clinical studies or clinical
  trials





·
            Failure
      to receive necessary regulatory
approvals





·
            Existence
      of proprietary rights of third parties;
and/or





·
            Inability
      to develop manufacturing methods that are efficient, cost-effective and
      capable of meeting stringent regulatory
  standards.





OUR
INABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS COULD NEGATIVELY IMPACT
OUR PROJECTED GROWTH AND ABILITY TO GENERATE REVENUES AND PROFITS, WHICH WOULD
HAVE A NEGATIVE IMPACT ON OUR BUSINESS AND THE VALUE OF YOUR
INVESTMENT.




We rely
on a combination of patent, patent pending, copyright, trademark and trade
secret laws, proprietary rights agreements and non-disclosure agreements to
protect our intellectual properties. We cannot give you any assurance that these
measures will prove to be effective in protecting our intellectual
properties.





In the
case of patents, we cannot give you any assurance that our existing patents will
not be invalidated, that any patents that we currently or prospectively apply
for will be granted, or that any of these patents will ultimately provide
significant commercial benefits. Further, competing companies may circumvent any
patents that we may hold by developing products which closely emulate but do not
infringe our patents. While we currently have and intend to seek patent
protection for our products in selected foreign countries, those patents may not
receive the same degree of protection as they would in the United States. We can
give you no assurance that we will be able to successfully defend our patents
and proprietary rights in any action we may file for patent infringement.
Similarly, we cannot give you any assurance that we will not be required to
defend against litigation involving the patents or proprietary rights of others,
or that we will be able to obtain licenses for these rights. Legal and
accounting costs relating to prosecuting or defending patent infringement
litigation may be substantial.





The
WavSTAT System is protected by eight issued patents, in the United States,
Canada, Europe and Japan, which we own, and one additional patent for which we
own the exclusive license. In October 2006, the Company filed for a patent
entitled “System and Method for Non-Endoscopic Optical Biopsy Detection of
Diseased Tissue”. Our LUMA system is the subject of 52 patent applications
worldwide, 38 of which have issued and 18 patents are pending.





We also
rely on proprietary designs, technologies, processes and know-how not eligible
for patent protection. We cannot give you any assurance that our competitors
will not independently develop the same or superior designs, technologies,
processes and know-how.


19


While we
have and will continue to enter into proprietary rights agreements with our
employees and third parties giving us proprietary rights to certain technology
developed by those employees or parties while engaged by the Company, we can
give you no assurance that courts of competent jurisdiction will enforce those
agreements.





THE
PATENTS WE OWN COMPRISE A LARGE PORTION OF OUR ASSETS, WHICH COULD LIMIT OUR
FINANCIAL VIABILITY.





The
WavSTAT System is protected by eight issued patents, in the United States,
Canada, Europe and Japan, and an additional patent for which we own an exclusive
license. One of the eight patents has lapsed for failure to pay maintenance
fees, and we are in the process of reinstating the patent. We cannot assure you
that we will be successful in reinstating the patent. In addition, our LUMA
System is the subject of 52 patent applications worldwide, 38 of which have been
issued with 18 patents pending. These patents comprise approximately 44% of our
assets at December 31, 2008. If our existing patents are invalidated or if they
fail to provide significant commercial benefits, it will severely hurt our
financial condition, as a significant percentage of our assets would lose their
value. Further, since our patents are amortized over the course of their term
until they expire, our assets comprised of patents will continually be written
down until they lose value altogether.




LEGISLATIVE
ACTIONS AND POTENTIAL NEW ACCOUNTING PRONOUNCEMENTS ARE LIKELY TO IMPACT OUR
FUTURE FINANCIAL POSITION AND RESULTS OF OPERATIONS.





There
have been regulatory changes, including the Sarbanes-Oxley Act of 2002, and
there may potentially be new accounting pronouncements or additional regulatory
rulings which will have an impact on our future financial position and results
of operations. The Sarbanes-Oxley Act of 2002 and other rule changes as well as
proposed legislative initiatives following the Enron bankruptcy have increased
general and administrative costs as we have incurred increased legal and
accounting fees to comply with such rule changes.





OUR
PRODUCTS MAY BE SUBJECT TO RECALL OR PRODUCT LIABILITY CLAIMS.





Our
WavSTAT and LUMA System products may be used in connection with medical
procedures in which it is important that those products function with precision
and accuracy. If our products do not function as designed, or are designed
improperly, we may be forced by regulatory agencies to withdraw such products
from the market. In addition, if medical personnel or their patients suffer
injury as a result of any failure of our products to function as designed, or an
inappropriate design, we may be subject to lawsuits seeking significant
compensatory and punitive damages. Any product recall or lawsuit seeking
significant monetary damages may have a material effect on our business and
financial condition.





WE HAVE
NOT PAID ANY CASH DIVIDENDS AND NO CASH DIVIDENDS WILL BE PAID IN THE
FORESEEABLE FUTURE.





We do not
anticipate paying cash dividends on our Common Stock in the foreseeable future,
and we cannot assure an investor that funds will be legally available to pay
dividends or that even if the funds are legally available, that the dividends
will be paid.





THE
APPLICATION OF THE "PENNY STOCK" RULES COULD ADVERSELY AFFECT THE MARKET PRICE
OF OUR COMMON STOCK AND INCREASE YOUR TRANSACTION COSTS TO SELL YOUR
STOCK.





As long
as the trading price of our Common Stock is below $5 per share, the open-market
trading of our Common Stock will be subject to the "penny stock" rules. The
"penny stock" rules impose additional sales practice requirements on
broker-dealers who sell securities to persons other than established customers
and accredited investors (generally those with assets in excess of $1,000,000 or
annual income exceeding $200,000 or $300,000 together with their spouse). For
transactions covered by these rules, the broker-dealer must make a special
suitability determination for the purchase of securities and have received the
purchaser's written consent to the transaction before the purchase.
Additionally, for any transaction involving a penny stock, unless exempt, the
broker-dealer must deliver, before the transaction, a disclosure schedule
prescribed by the SEC relating to the penny stock market. The broker-dealer also
must disclose the commissions payable to both the broker-dealer and the
registered representative and current quotations for the securities. Finally,
monthly statements must be sent disclosing recent price information on the
limited market in penny stocks. These additional burdens imposed on
broker-dealers may restrict the ability or decrease the willingness of
broker-dealers to sell our Common Stock, and may result in decreased liquidity
for our Common Stock and increased transaction costs for sales and purchases of
our Common Stock as compared to other securities.





OUR
COMMON STOCK IS THINLY TRADED, SO INVESTORS MAY BE UNABLE TO SELL AT OR NEAR ASK
PRICES OR AT ALL.





Our
Common Stock has historically been sporadically or "thinly-traded", meaning that
the number of persons interested in purchasing our Common Stock at or near ask
prices at any given time may be relatively small or non-existent. As of March
25, 2009, our average trading volume per day for the past three months was
approximately 29,000 shares a day with a high of 194,300 shares traded and a low
of 0 shares traded per day. This situation is attributable to a number of
factors, including the fact that we are a small company which is relatively
unknown to stock analysts, stock brokers, institutional investors and others in
the investment community that generate or influence sales volume, and that even
if we came to the attention of such persons, they tend to be risk-averse and
would be reluctant to follow an unproven company such as ours or purchase or
recommend the purchase of our shares until such time as we became more seasoned
and viable. As a consequence, there may be periods of several days or more when
trading activity in our shares is minimal or non-existent, as compared to a
seasoned issuer which has a large and steady volume of trading activity that
will generally support continuous sales without an adverse effect on share
price. We cannot give you any assurance that a broader or more active public
trading market for our Common Stock will develop or be sustained, or that
current trading levels will be sustained.


20





THE
MARKET PRICE FOR OUR COMMON STOCK IS PARTICULARLY VOLATILE, GIVEN OUR STATUS AS
A RELATIVELY UNKNOWN COMPANY WITH A SMALL AND THINLY-TRADED PUBLIC FLOAT,
LIMITED OPERATING HISTORY AND LACK OF REVENUES WHICH COULD LEAD TO WIDE
FLUCTUATIONS IN OUR SHARE PRICE. THE PRICE AT WHICH YOU PURCHASE OUR COMMON
STOCK MAY NOT BE INDICATIVE OF THE PRICE THAT WILL PREVAIL IN THE TRADING
MARKET. AN INVESTOR MAY BE UNABLE TO SELL COMMON STOCK AT OR ABOVE THE PURCHASE
PRICE, WHICH MAY RESULT IN SUBSTANTIAL LOSSES.





The
market for our Common Stock is characterized by significant price volatility
when compared to seasoned issuers, and we expect that our share price will
continue to be more volatile than a seasoned issuer for the indefinite future.
In fact, during the ninety-day period ended March 25, 2009, the high and low
closing prices of a share of our Common Stock were $0.33 and $0.15,
respectively. The volatility in our share price is attributable to a number of
factors. First, as noted above, our stock is sporadically and/or thinly-traded.
As a consequence of this lack of liquidity, the trading of relatively small
quantities of shares by our stockholders may disproportionately influence the
price of those shares in either direction. The price for our shares could, for
example, decline precipitously in the event that a large number of our shares
are sold on the market without commensurate demand, as compared to a seasoned
issuer which could better absorb those sales without adverse impact on its share
price. Secondly, we are a speculative or "risky" investment due to our limited
operating history and lack of revenues or profits to date and uncertainty of
future market acceptance for our potential products. As a consequence of this
enhanced risk, more risk-adverse investors may, under the fear of losing all or
most of their investment in the event of negative news or lack of progress, be
more inclined to sell their shares on the market more quickly and at greater
discounts than would be the case with the stock of a seasoned issuer. The
following factors may add to the volatility in the price of our Common Stock:
actual or anticipated variations in our quarterly or annual operating results;
acceptance of our proprietary technology; government regulations, announcements
of significant acquisitions, strategic partnerships or joint ventures; our
capital commitments; and additions or departures of our key personnel. Many of
these factors are beyond our control and may decrease the market price of our
Common Stock, regardless of our operating performance. We cannot make any
predictions or projections as to what the prevailing market price for our Common
Stock will be at any time, including as to whether our Common Stock will sustain
their current market prices, or as to what effect that the sale of shares or the
availability of Common Stock for sale at any time will have on the prevailing
market price.





Shareholders
should be aware that, according to SEC Release No. 34-29093, the market for
penny stocks has suffered in recent years from patterns of fraud and abuse. Such
patterns include (1) control of the market for the security by one or a few
broker-dealers that are often related to the promoter or issuer; (2)
manipulation of prices through prearranged matching of purchases and sales and
false and misleading press releases; (3) boiler room practices involving
high-pressure sales tactics and unrealistic price projections by inexperienced
sales persons; (4) excessive and undisclosed bid-ask differential and markups by
selling broker-dealers; and (5) the wholesale dumping of the same securities by
promoters and broker-dealers after prices have been manipulated to a desired
level, along with the resulting inevitable collapse of those prices and with
consequent investor losses. Our management is aware of the abuses that have
occurred historically in the penny stock market. Although we do not expect to be
in a position to dictate the behavior of the market or of broker-dealers who
participate in the market, management will strive within the confines of
practical limitations to prevent the described patterns from being established
with respect to our securities. The occurrence of these patterns or practices
could increase the volatility of our share price.





VOLATILITY
IN OUR COMMON STOCK PRICE MAY SUBJECT US TO SECURITIES LITIGATION.





The
market for our Common Stock is characterized by significant price volatility
when compared to seasoned issuers, and we expect that our share price will
continue to be more volatile than a seasoned issuer for the indefinite future.
In the past, plaintiffs have sometimes initiated securities class action
litigation against a company following periods of volatility in the market price
of its securities. We may in the future be the target of similar litigation.
Securities litigation could result in substantial costs and liabilities and
could divert management's attention and resources.





OUR
OFFICERS AND DIRECTORS OWN OR CONTROL APPROXIMATELY 30% (INCLUDING ALL OPTIONS
EXERCISABLE WITHIN 60 DAYS OF March 25, 2009) OF OUR OUTSTANDING COMMON STOCK,
WHICH MAY LIMIT THE ABILITY OF OTHER STOCKHOLDERS, WHETHER ACTING SINGLY OR
TOGETHER, TO PROPOSE OR DIRECT THE MANAGEMENT OR OVERALL DIRECTION OF THE
COMPANY. ADDITIONALLY, THIS CONCENTRATION OF OWNERSHIP COULD DISCOURAGE OR
PREVENT A POTENTIAL TAKEOVER OF THE COMPANY THAT MIGHT OTHERWISE RESULT IN
STOCKHOLDERS RECEIVING A PREMIUM OVER THE MARKET PRICE FOR THEIR COMMON
STOCK.


21


As of
March 25, 2009, our officers and directors beneficially own or control
approximately 30% (including all options exercisable within sixty days of March
25, 2009) of our outstanding Common Stock. These persons will have the ability
to control substantially all matters submitted to our stockholders for approval
and to control our management and affairs, including extraordinary transactions
such as mergers and other changes of corporate control, and going private
transactions.





A LARGE
NUMBER OF SHARES OF COMMON STOCK ARE ISSUABLE UPON EXERCISE OF OUTSTANDING
OPTIONS. THE EXERCISE OF THESE SECURITIES COULD RESULT IN THE SUBSTANTIAL
DILUTION OF THE INVESTMENT OF OTHER STOCKHOLDERS IN TERMS OF PERCENTAGE
OWNERSHIP IN THE COMPANY AS WELL AS THE BOOK VALUE OF THE COMMON STOCK. THE SALE
OF A LARGE AMOUNT OF COMMON STOCK RECEIVED UPON EXERCISE OF THESE OPTIONS ON THE
PUBLIC MARKET TO FINANCE THE EXERCISE PRICE OR TO PAY ASSOCIATED INCOME TAXES,
OR THE PERCEPTION THAT SUCH SALES COULD OCCUR, COULD SUBSTANTIALLY DEPRESS THE
PREVAILING MARKET PRICES FOR OUR STOCK.




As of
March 25, 2009, there are outstanding common stock purchase options entitling
the holders to purchase 8,150,000 shares of Common Stock at a weighted average
exercise price of $0.59 per share (4,216,667 of these shares are exercisable
within the next 60 days). The exercise price for all of the aforesaid options
may be less than your cost to acquire our Common Stock. In the event of the
exercise or conversion of these securities, you could suffer substantial
dilution of your investment in terms of your percentage ownership in the company
as well as the book value of your Common Stock. In addition, the holders of the
common share purchase options may sell Common Stock in tandem with their
exercise of those options to finance that exercise, or may resell the shares
purchased in order to cover any income tax liabilities that may arise from their
exercise of the options.





OUR
ISSUANCE OF ADDITIONAL COMMON STOCK, OR OPTIONS TO PURCHASE OUR STOCK, WOULD
DILUTE YOUR PROPORTIONATE OWNERSHIP AND VOTING RIGHTS.





We are
entitled under our articles of incorporation to issue up to 125,000,000 shares
of capital stock, including 100,000,000 shares of Common Stock and 25,000,000
undesignated shares (our undesignated shares may be designated as in a senior
position to the current stock). After taking into consideration our outstanding
Common Stock at March 25, 2009, we will be entitled to issue up to 6,942,294
additional shares of Common Stock (100,000,000 authorized less shares
outstanding of 69,707,615, 11,558,974 shares reserved for issuance to Fusion
Capital, 10,456,142 shares reserved for issuance of stock options, 787,966
shares reserved for placement agent warrants and 547,009 shares reserved for
Fusion Capital as allocable commitment shares and up to 25,000,000 shares of
undesignated capital stock. Our board of directors may generally issue stock, or
options or warrants to purchase those shares, without further approval by our
stockholders based upon such factors as our board of directors may deem relevant
at that time. It is likely that we will be required to issue a large amount of
additional securities to raise capital to further our development. It is also
likely that we will be required to issue a large amount of additional securities
to directors, officers, employees and consultants as compensatory grants in
connection with their services, both in the form of stand-alone grants or under
our stock plans. We cannot give you any assurance that we will not issue
additional Common Stock, or options or warrants to purchase those shares, under
circumstances we may deem appropriate at the time.





THE
LIMITATION OF MONETARY LIABILITY OF OUR DIRECTORS, OFFICERS AND EMPLOYEES UNDER
OUR ARTICLES OF INCORPORATION AND THE INDEMNIFICATION RIGHTS OF OUR DIRECTORS,
OFFICERS, CONSULTANTS AND EMPLOYEES MAY RESULT IN SUBSTANTIAL EXPENDITURES BY
OUR COMPANY AND MAY DISCOURAGE LAWSUITS AGAINST OUR DIRECTORS, OFFICERS,
CONSULTANTS AND EMPLOYEES.





Our
articles of incorporation contain provisions which eliminate the liability of
our directors for monetary damages to the Company and stockholders. Our bylaws
also require us to indemnify our officers and directors. We may also have
contractual indemnification obligations under our agreements with our directors,
officers, consultants and employees. The foregoing indemnification obligations
could result in our company incurring substantial expenditures to cover the cost
of settlement or damage awards against directors, officers, consultants and
employees, which we may be unable to recoup. These provisions and resultant
costs may also discourage the Company from bringing a lawsuit against directors,
officers, consultants and employees for breaches of their fiduciary duties, and
may similarly discourage the filing of derivative litigation by our stockholders
against our directors, officers, consultants and employees even though such
actions, if successful, might otherwise benefit the Company and
stockholders.




ANTI-TAKEOVER
PROVISIONS MAY IMPEDE THE ACQUISITION OF OUR COMPANY.





Certain
provisions of the Minnesota Business Corporation Act and other Minnesota laws
have anti-takeover effects and may inhibit a non-negotiated merger or other
business combination. These provisions are intended to encourage any person
interested in acquiring us to negotiate with, and to obtain the approval of, our
Board of Directors in connection with such a transaction. However, certain of
these provisions may discourage a future acquisition of the Company, including
an acquisition in which the stockholders might otherwise receive a premium for
their shares. As a result, stockholders who might desire to participate in such
a transaction may not have the opportunity to do so.


22





ITEM 1B.
UNRESOLVED STAFF COMMENTS.





None





ITEM 2.
DESCRIPTION OF PROPERTIES.





SpectraScience
leases its principal facility from an unrelated third party. The facility
consists of approximately 5,080 square feet of office, research and development,
manufacturing, quality testing, and warehouse space. The lease provides for
monthly rental payments of $5,334 through December 2009, plus a pro rata share
of operating expense and real estate taxes (approximately $1,050 per month). In
the event of the termination of this lease, we believe that we could lease other
acceptable space on a comparable basis.





ITEM 3.
LEGAL PROCEEDINGS.





We are
not currently a party to any legal proceedings.





ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.





None.





PART
II





ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES.





Market
Information





Our
common stock is quoted on the over-the-counter bulletin board under the symbol
SCIE.OB. The last reported bid price of the common stock on March 25, 2009 was
$0.20.





The
following table sets forth for the calendar period indicated; the quarterly high
and low bid prices of our Common Stock as reported by the OTCBB. The prices
represent quotations between dealers, without adjustment for retail markup,
markdown or commission, and do not necessarily represent actual
transactions.




BID PRICEPERIOD
                      
                      HIGH
                      
                      
                      LOW2008:Fourth
      Quarter
                      
                      $
                      0.50
                      
                      
                      $
                      0.21Third
      Quarter
                      
                      
                      0.68
                      
                      
                      
                      0.40Second
      Quarter
                      
                      
                      1.01
                      
                      
                      
                      0.61First
      Quarter
                      
                      
                      1.05
                      
                      
                      
                      0.702007:Fourth
      Quarter
                      
                      
                      1.33
                      
                      
                      
                      0.84Third
      Quarter
                      
                      
                      1.26
                      
                      
                      
                      0.75Second
      Quarter
                      
                      
                      1.65
                      
                      
                      
                      0.96First
      Quarter
                      
                      
                      1.40
                      
                      
                      
                      0.76





On March
25, 2009 we had approximately 750 registered stockholders of record of the
69,696,653 shares of our common stock. We estimate that there are approximately
4,000 beneficial stockholders of our common stock.





To date,
we have not declared or paid cash dividends on our common stock. The current
policy of the Board of Directors is to retain any earnings to fund the
development and growth of our business. Any future determination to pay cash
dividends will be at the discretion of our Board of Directors, and will be
dependent upon our financial condition, results of operations, capital
requirements and other factors our board may deem relevant at the
time.


23


The
transfer agent and registrar for our common stock is Wells Fargo Shareowner
Services, located at 161 N. Concord Exchange, South Saint Paul, Minnesota 55075.
Their telephone number is (800) 468-9716.





Recent Sales of Unregistered
Securities





Fiscal
Year Ended December 31, 2008





Common
Stock





In
December 2008, the Company issued 100,000 restricted common shares to Fusion
Capital in payment of expenses related to a proposed financing. The fair value
of the shares was determined to be, and the company capitalized an amount of
$33,000, based upon the market value of the stock on the date of issuance. This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





In June
2008, the Company issued 10,000 restricted common shares to a vendor for
services. The fair value of the shares was determined to be $7,500, and the
company recognized expense in the amount of $7,500, based upon the market value
of the stock on the date of issuance.





In
February 2008, the Company issued 615,386 shares of Common Stock to accredited
investors at a price of $0.70 per share for an aggregate consideration of
$430,770. The Company received net cash proceeds of approximately $377,000 after
placement agent commissions and expenses of $42,770. This transaction was exempt
from the registration requirements of the Securities Act of 1933 pursuant to
Regulation D promulgated under the Securities Act of 1933.





In
May 2008, the Company issued 121,470 shares of Common Stock to accredited
investors at a price of $0.70 per share for an aggregate consideration of
$85,000 in the final closing tranche of the Financing. The Company received net
cash proceeds of approximately $68,000 after placement agent commissions and
expenses of approximately $17,000. This transaction was exempt from the
registration requirements of the Securities Act of 1933 pursuant to Regulation D
promulgated under the Securities Act of 1933.





Series
A Convertible Preferred Stock





In March
2008, the holder of 2,000,000 shares of Series A Convertible Preferred stock
converted his shares into 8,000,000 shares of restricted Common Stock. The
Series A Convertible Preferred Stock was converted into Common Stock at a
conversion price of $0.125 per share. The Company received no proceeds as a
result of the transaction.  This transaction was exempt from the
registration requirements of the Securities Act of 1933 pursuant to Regulation D
promulgated under the Securities Act of 1933.





Series
A Convertible Preferred Stock Warrants





In
December 2008 the holders of 71,250 of the Company’s Series A Preferred Warrants
effected a cashless exercise of their warrants in exchange for 147,981
restricted common shares. The Company received no proceeds as a result of the
exercise. This transaction was exempt from the registration requirements of the
Securities Act of 1933 pursuant to Regulation D promulgated under the Securities
Act of 1933.





In May
2008 the holders of 153,750 of the Company’s Series A Preferred Warrants
effected a cashless exercise of their warrants in exchange for 521,249
restricted common shares. The Company received no proceeds as a result of the
exercise. This transaction was exempt from the registration requirements of the
Securities Act of 1933 pursuant to Regulation D promulgated under the Securities
Act of 1933.





In April
2008 a holder of 25,000 of the Company’s Series A Preferred Warrants effected a
cashless exercise of his warrants in exchange for 84,568 restricted common
shares. The Company received no proceeds as a result of the exercise. This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





Common
Stock Purchase Warrants





In May
2008, as additional consideration associated with a private placement of Common
Stock, the Company issued 73,681 five-year cashless warrants to purchase an
equal number of common shares at $0.80 per share to Advanced Equities, Inc., the
placement agent associated with the placement. The Company is obligated to
reserve 73,681 common shares under these warrants and the shares underlying the
warrants are subject to a registration rights agreement. This transaction was
exempt from the registration requirements of the Securities Act of 1933 pursuant
to Regulation D promulgated under the Securities Act of 1933.





Stock
Options





In May
2008, 20,000 stock options held by an employee were exercised. The Company
received net proceeds of $3,000 as a result of the exercise.


24


Fiscal
Year Ended December 31, 2007





Common
Stock





In
December 2007, the Company issued 7,142,857 shares of Common Stock to accredited
investors at a price of $0.70 per share. The Company received net cash of
approximately $4,379,000 after placement agent commissions and expenses of
$600,000 and other transaction expenses of approximately $21,000. This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





In
November 2007, the Company issued 11,200,000 shares of restricted Common Stock
to accredited investors in exchange for the assets of LUMA Imaging Corporation.
The price paid was based on the fair-value of the underlying assets received,
which totaled approximately $5,025,000 or $0.45 per share. This transaction was
exempt from registration pursuant to Section 4(2) promulgated under the
Securities Act of 1933.





From
March through May of 2007, the Company issued 2,270,000 shares of Common Stock
at a price of $0.50 per share to accredited investors for $1,135,000 in cash.
This transaction was exempt from the registration requirements of the Securities
Act of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





Series
A Convertible Preferred Stock





In June
2007, the Company issued 2,000,000 shares of Series A Convertible Preferred
Stock (“Preferred”) to accredited investors at a price of $0.50 per share for
$1,000,000 in cash. As of December 31, 2007, the Preferred is convertible into
Common Stock.  This transaction was exempt from the registration
requirements of the Securities Act of 1933 pursuant to Regulation D promulgated
under the Securities Act of 1933.





Series
A Convertible Preferred Stock Purchase Warrants





In June
2007, the Company issued five-year warrants to accredited investors to purchase
250,000 shares of Series A Preferred at $0.50 per share.  This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





Common
Stock Purchase Warrants





In
December 2007, the Company issued 714,285 five-year warrants to purchase Common
Stock at $0.80 per share to Advanced Equities, Inc., the Placement Agent
associated with the December private equity financing.  This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





ITEM
6.          SELECTED FINANCIAL
DATA





Not
required.





ITEM
7.          MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





The
following discussion and analysis provides information that management believes
is relevant to assess and understand our results of operations and financial
condition. This discussion should be read in conjunction with the consolidated
financial statements and footnotes that follow such consolidated financial
statements.





Certain
statements contained herein that are not related to historical results,
including, without limitation, statements regarding the Company's business
strategy and objectives, future financial position, expectations about pending
litigation and estimated cost savings, are forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Securities
Exchange Act of 1934, as amended (the "Securities Exchange Act") and involve
risks and uncertainties. Although we believe that the assumptions on which these
forward-looking statements are based are reasonable, there can be no assurance
that such assumptions will prove to be accurate and actual results could differ
materially from those discussed in the forward-looking statements. Factors that
could cause or contribute to such differences include, but are not limited to,
regulatory policies, competition from other similar businesses, and market and
general economic factors. All forward-looking statements contained in this Form
10-K are qualified in their entirety by this statement.


25





Plan of
Operation





In the
third fiscal quarter of 2008, the Company began selling its products and is no
longer a development stage company. The Company currently has FDA approval to
market the WavSTAT System for detecting pre-cancerous and cancerous tissue in
the colon and to market the LUMA System for use as an adjunct to colposcopy in
the detection of early stage cancer and pre-cancer of the cervix. Our plan is to
add another indication for use in detecting pre-cancer and cancer in the
esophagus. Over the next twelve months, SpectraScience intends to:





·
            Continue selling the WavSTAT
      System in the US and international markets for the detection and treatment
      of colon cancer and
pre-cancer.





·
            Complete WavSTAT System clinical
      trials related to the diagnosis of esophageal
    cancers.





·
            Begin marketing and selling the
      WavSTAT System in US and international markets for the detection of
      esophageal cancer and
pre-cancer.





·
            Position and begin selling or
      renting the LUMA System in the US as an adjunct to colposcopy to
      specialized OB/GYN clinics (increase revenue), managed care organizations
      (early detection and future cost avoidance), teaching hospitals and
      medical environments where nurse practitioners and/or medical clinicians
      can leverage our technology for effective early
      diagnosis.





·
            Enhance our San Diego facility
      and grow our organization to allow for the manufacture of both WavSTAT and
      LUMA Systems in-house and also to begin the design and planning for the
      next generation of fluorescence-based
  systems.





Cash
Requirements





SpectraScience
expects to incur significant additional operating losses through 2009, as we
complete clinical trials, begin outcome-based clinical studies, continue
research and development activities, and ramp up sales and marketing efforts to
sell both the WavSTAT and LUMA Systems. We may incur unexpected expenses, or we
may not be able to meet our revenue forecast, and such events will require us to
seek additional capital.





SpectraScience
has financed its capital requirements principally through the private sale of
equity securities. The Company had cash and cash equivalents of approximately
$1,618,000 at December 31, 2008 and $5,188,000 at December 31, 2007. The
decrease in cash for the fiscal year was a result of approximately $4,018,000
cash used in operations and acquisitions of equipment offset by sales of common
stock for net proceeds of approximately $448,000. SpectraScience expects that we
will require additional sales of equity securities to provide sufficient working
capital for planned operations for the next twelve months.





SpectraScience’s
future liquidity and capital requirements will depend upon a number of factors,
including but not limited to:





·
            The timing and progress of
      outcome-based clinical
trials





·
            The timing and extent to which
      SpectraScience’s products gain market
  acceptance





·
            The timing and expense of
      developing marketing and distribution
  channels





·
            The progress and expense of
      developing next generation products and new applications for the WavSTAT
      and LUMA Systems





·
            The potential requirements and
      related costs for product
modifications





·
            The timing and expense of various
      U.S. and foreign regulatory
filings





·
            The maintenance of various U.S.
      and foreign government approvals, or the timing of receipt of additional
      approvals, and





·
            The status, maintenance and
      enhancement of SpectraScience’s patent
  portfolio.




·
            The overall effect of the present
      global economic recession on the ability of the Company to generate sales
      revenue.


26





The
Fusion Transaction





On
January 30, 2009, we signed a $6.0 million common stock purchase agreement with
Fusion Capital Fund II, LLC, an Illinois limited liability
company.  Concurrently with entering into the common stock purchase
agreement, we entered into a registration rights agreement with Fusion
Capital.  Under the registration rights agreement, we agreed to file a
registration statement related to the transaction with the U.S. Securities &
Exchange Commission (“SEC”) covering the shares that have been issued or may be
issued to Fusion Capital under the common stock purchase
agreement.  After the SEC has declared effective the registration
statement related to the transaction, we have the right over a 24-month period
to sell our shares of common stock to Fusion Capital from time to time in
amounts between $25,000 and $1 million, depending on certain conditions as set
forth in the agreement, up to an aggregate of $6.0 million.  The
Company will control the timing and amount of any sales of shares to Fusion
Capital.





The
purchase price of the shares related to the $6.0 million of future funding will
be based on the prevailing market prices of the Company’s shares at the time of
sales without any fixed discount.  Fusion Capital shall not have the
right or the obligation to purchase any shares of our common stock on any
business day that the price of our common stock is below $0.15.  The
common stock purchase agreement may be terminated by us at any time at our
discretion without any cost to us.  There are no negative covenants,
restrictions on future fundings, penalties or liquidated damages in the
agreement.  The proceeds to be received by the Company under the
common stock purchase agreement will be used for working capital and general
corporate purposes.





In
consideration for entering into the agreement, upon execution of the common
stock purchase agreement we have issued to Fusion Capital 1,094,017 shares of
our common stock as a commitment fee. Also, we will issue to Fusion Capital an
additional 547,009 shares as a commitment fee pro rata as we receive the $6.0
million of future funding.





The
foregoing description of the common stock purchase agreement and the
registration rights agreement are qualified in their entirety by reference to
the full text of the common stock purchase agreement and the registration rights
agreement, a copy of each of which is attached hereto as Exhibit 10.1 and 10.2,
respectively, and each of which is incorporated herein in its entirety by
reference.





Management’s Discussion and
Analysis of Financial Condition and Results of Operations




The
following discussion should be read in conjunction with the consolidated
Financial Statements and Notes thereto appearing elsewhere in this
report.





Fiscal
Year Ended December 31, 2008 As Compared To Fiscal Year Ended December 31,
2007





Operating
Expenses





Consolidated
operating expenses were $5,304,762 (of which approximately $992,000 was for
non-cash compensation from stock options) for the fiscal year ended
December 31, 2008, versus $3,020,588 (of which approximately $1,401,000 was for
non-cash compensation from stock options) for the comparable period one
year ago. The net increase of $2,284,174 was comprised of a $1,423,063 increase
in research and development expenses, a $646,758 increase in general and
administrative expenses and a $214,353 increase in sales and marketing
expenses.





Research
and development expenses increased by $1,423,063 due to an increase of $876,026
in payroll expense, a $268,406 increase in stock option compensation expense, a
$181,509 increase in product development expense, a $54,570 increase in clinical
trial expense, a $46,855 increase in production supplies expense and a net
$4,304 decrease in all other research and development expenses. . All of the
increases were a result of the additional activity and effort invested in the
development and commercialization of the WavSTAT and LUMA Systems for the fiscal
year ended December 31, 2008.




General
and administrative expenses increased $646,758 due to a $306,626 increase in
administrative payroll expense, a $223,858 increase in depreciation and
amortization, a $149,637 increase in patent legal expense, a $79,494 increase in
audit related expense, a $67,245 increase in recruiting fees, a $61,117 increase
in rent and occupancy expenses, a $54,820 increase in travel expense, a $16,778
increase in investor relations expense a $45,110 increase in consulting expense
and a $132,779 increase in all other expenses all offset by a $490,706 decrease
in  stock compensation expense. The overall increase in most
categories of general and administrative expense reflects the increased
activity, larger organization and shift from development to commercialization of
our systems in fiscal 2008 as compared to 2007. The increase in depreciation and
amortization expense is primarily a result of the acquisition of the LUMA patent
portfolio in November 2007, and its subsequent amortization for the full 2008
fiscal year. The decrease in stock compensation expense results primarily from a
higher number of stock options granted in the prior fiscal year.





Sales and
marketing expenses increased by $214,353. The increase was comprised of $289,216
in sales payroll expense, a $62,422 increase in trade show expense, a $21,866
increase in advertising expense, a $10,106 increase in travel expense and a
$19,916 increase in all other sales expenses offset by an $189,173 decrease in
stock compensation expense. The decrease in stock compensation expense results
from a general increase in the vesting terms of recent stock option grants and
the relatively low market price of Company stock as compared to the prior fiscal
year.


27





Other
Income





Other
income, net increased $80,427 due to interest earnings on higher average cash
balances for the year as compared to the prior fiscal year.





Off Balance Sheet
Arrangements





The
Company has no Off Balance Sheet arrangements.





Critical Accounting Policies
and Estimates





This
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these consolidated financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate these estimates, including
those related to intangibles, income taxes, financing operations, contingencies
and litigation. We base our estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.





We have
identified the policies below as critical to our business operations and the
understanding of our results of operations. The impact and any associated risks
related to these policies on our business operations is discussed throughout
Management's Discussion and Analysis or Plan of Operation where such policies
affect our reported and expected financial results. Note that our preparation of
this Report on Form 10-K requires us to make estimates and assumptions that
affect the reported amount of assets and liabilities, disclosure of contingent
assets and liabilities at the date of our consolidated financial statements, and
the reported amount of revenue, if any, and expenses during the reporting
period. There can be no assurance that actual results will not differ from those
estimates.





Accounting
For Transactions Involving Stock Compensation





In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) 123(R) (revised 2004),
"Share-Based Payment", (“SFAS 123(R)”) which amends FASB Statement 123 and was
effective for public companies for annual periods beginning after December 15,
2005. The new standard requires us to expense employee stock options and other
share-based payments. Since inception on August 2, 2004, the Company has been
recording to expense the fair value of employee and non-employee options. These
expenses amounted to $992,223 and $1,401,096 for the years ended December 31,
2008 and 2007, respectively.





Impairment
or Disposal of Long-Lived Assets




SFAS No.
144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS
144”), addresses financial accounting and reporting for the impairment or
disposal of long-lived assets (such as our patents). SFAS 144 requires that
long-lived assets be reviewed for impairment whenever events or changes in
circumstances indicate that their carrying amounts may not be recoverable. If
the cost basis of a long-lived asset is greater than the projected future
undiscounted net cash flows from such asset (excluding interest), an impairment
loss is recognized. Impairment losses are calculated as the difference between
the cost basis of an asset and its estimated fair value. SFAS 144 also requires
companies to separately report discontinued operations and extends that
reporting requirement to a component of an entity that either has been disposed
of (by sale, abandonment or in a distribution to owners) or is classified as
held for sale. Assets to be disposed of are reported at the lower of the
carrying amount or the estimated fair value less costs to sell.





Accounting
for Income Taxes





In July
2006, the Financial Accounting Standards Board issued Financial Interpretation
No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”, which applies
to all tax positions related to income taxes subject to SFAS 109, “Accounting
for Income Taxes”. FIN 48 requires a new evaluation process for all tax
positions taken. If the probability for sustaining said tax position is greater
than 50%, then the tax position is warranted and recognition should be at the
highest amount which would be expected to be realized upon ultimate settlement.
FIN 48 requires expanded disclosure at each annual reporting period unless a
significant change occurs in an interim period. Differences between the amounts
recognized in the statements of financial position prior to the adoption of FIN
48 and the amounts reported after adoption are to be accounted for as an
adjustment to the beginning balance of retained earnings. The Company has
completed its initial evaluation and implementation of the impact of the January
1, 2007 adoption of FIN 48 and determined that the Company does not have
uncertain tax positions on its 2004, 2005, 2006 and 2007 tax returns. Based on
evaluation of the 2008 transactions and events, the Company does not have any
uncertain tax positions that require measurement. The Company had a full
valuation allowance on its deferred tax assets as of December 31, 2007 and 2008,
and has not recognized any tax benefits since inception.


28





Recent
Accounting Pronouncements




In June
2008, the Emerging Issues Task Force (EITF) ratified a consensus on EITF Issue
No. 07-05, “Determining Whether an Instrument (or Embedded Feature) is Indexed
to an Entity’s Own Stock” which provides guidance for determining whether an
equity-linked financial instrument (or embedded feature) is indexed to an
entity’s own stock. EITF Issue No. 07-5 provides for a two-step approach for the
evaluation of a financial instrument’s contingent exercise and settlement
provisions to determine if the instrument is indexed to an entity’s own stock.
The Task Force reached a consensus that this Issue should be effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. Early application is not
permitted. On December 31, 2008, the Company had no instruments outstanding
which would have required the application of EITF No. 07-05. Management is
currently assessing the impact, if any, that EITF Issue No. 07-5 may have on the
Company.





In
December 2007, the FASB issued No. 141(R), “Business Combinations” (“SFAS
141(R)”). SFAS 141(R) replaces SFAS 141 and provides greater consistency in the
accounting and financial reporting of business combinations. SFAS 141(R)
requires the acquiring entity in a business combination to recognize all assets
acquired and liabilities assumed in the transaction and any non-controlling
interest in the acquiree at the acquisition date and be measured at the fair
value as of that date. This includes the measurement of the acquirer’s shares
issued in consideration for a business combination, the recognition of
contingent consideration, the accounting for pre-acquisition gain and loss
contingencies, the recognition of capitalized in-process research and
development, the accounting for acquisition related restructuring cost accruals,
the treatment of acquisition related transaction costs and the recognition of
changes in the acquirer’s income tax valuation allowance and deferred taxes.
SFAS 141(R) will be effective for the Company on January 1, 2009 and is to
be applied prospectively. Early adoption is not permitted. Management is
currently assessing the impact, if any, that SFAS 141(R) may have on the
Company.





In
November 2007, the Emerging Issues Task Force (EITF) ratified a consensus on
EITF Issue No. 07-1, “Accounting for Collaborative Arrangements” (“EITF
07-1”) which requires participants in a collaboration to make separate
disclosures regarding the nature and purpose of an arrangement, their rights and
obligations under the arrangement, the accounting policy for the arrangement and
the income statement classification and amounts arising from the arrangement
between participants for each period an income statement is presented. EITF 07-1
is effective for us beginning in the first quarter of fiscal year 2009. We are
currently evaluating the impact of the provisions of EITF 07-1 on our financial
position, results of operations and cash flows and therefore, the impact of the
adoption is unknown at this time.




In June
2007, the EITF ratified a consensus on EITF Issue No. 07-3 (“EITF 07-3”),
“Accounting for Non-Refundable Advance Payments for Goods or Services to Be Used
in Future Research and Development Activities,” which concluded that
non-refundable advance payments for goods or services for use in research and
development activities should be deferred and capitalized. EITF 07-3 is
effective for us beginning in the first quarter of fiscal year 2008. We are
currently evaluating the impact of the provisions of EITF 07-3 on our financial
position, results of operations and cash flows and therefore, the impact of the
adoption is unknown at this time.





Other
accounting standards that may have been issued or proposed by the FASB or other
standards-setting bodies are not expected to have a material impact on the
Company’s consolidated financial statements.




ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK




The
Company carries no market risk sensitive instruments on its balance
sheet.




ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.





Consolidated
audited financial statements for the years ended December 31, 2008 and 2007 are
filed as part of this Form 10-K.


29





SpectraScience,
Inc. and Subsidiary


Consolidated
Financial Statements


Years
Ended December 31, 2008, and 2007




PageReport
      of Independent Registered Public Accounting Firm
              
              
              31Report
      of Independent Registered Public Accounting Firm
              
              
              32Consolidated
      Balance Sheets as of December 31, 2008 and 2007
              
              
              33Consolidated
      Statements of Operations for the years ended December 31, 2008 and
      2007
              
              
              34Consolidated
      Statements of Stockholders’ Equity from December 31, 2006 to December 31,
      2008
              
              
              35Consolidated
      Statements of Cash Flows for the years ended December 31, 2008 and
      2007
              
              
              36Notes
      to Consolidated Financial Statements
              
              
              37


30





Report
of Independent Registered Public Accounting Firm




To the
Board of Directors and Stockholders


SpectraScience,
Inc. and Subsidiary





We have
audited the accompanying consolidated balance sheet of SpectraScience, Inc. and
subsidiary as of December 31, 2008 and the related consolidated statements of
operations, stockholders’ equity, and cash flows for the year then ended. These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on
our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of SpectraScience, Inc. and
subsidiary as of December 31, 2008, and the results of their operations and
their cash flows for the year then ended, in conformity with U.S. generally
accepted accounting principles.





The
Company’s financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note 2 to the financial statements,
the Company has incurred losses and negative cash flows from operating
activities from its inception. As of December 31, 2008, management believes that
the Company will require additional financing to fund its operations, but cannot
assure that such financing will be available. Such matters raise substantial
doubt about the Company’s ability to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.





We were
not engaged to examine management’s assessment of the effectiveness of
SpectraScience, Inc’s internal control over financial reporting as of December
31, 2008, included in the accompanying management’s reportincluded
in Form 10-K and, accordingly, we do not express an opinion
thereon.





/s/
McGladrey & Pullen





Des
Moines, Iowa


March 30,
2008


31





Report
of Independent Registered Public Accounting Firm




To the
Stockholders and Board of Directors


SpectraScience,
Inc.




We have
audited the accompanying consolidated balance sheet of SpectraScience, Inc. and
subsidiary as of December 31, 2007, and the related consolidated statements of
operations, stockholders’ equity and cash flows for the year then ended.
These consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of SpectraScience, Inc. and
subsidiary as of December 31, 2007, and their results of operations and cash
flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America.





/s/ J.H.
Cohn LLP





San
Diego, California


March 27,
2008


32





SpectraScience,
Inc. and Subsidiary


Consolidated
Balance Sheets


December
31, 2008 and 2007





December 31,
                    2008
                  
                  
                  December 31,
                    2007ASSETSCurrent
      assets:Cash
      and cash equivalents
                  
                  $
                  1,618,181
                  
                  
                  $
                  5,188,177Accounts
      receivable
                  
                  
                  23,877
                  
                  
                  
                  -Inventories
                  
                  
                  465,881
                  
                  
                  
                  1,044,856Prepaid
      expenses and other current assets
                  
                  
                  85,344
                  
                  
                  
                  41,437Total
      current assets
                  
                  
                  2,193,283
                  
                  
                  
                  6,274,470Fixed
      assets, net
                  
                  
                  1,876,738
                  
                  
                  
                  943,482Patents,
      net
                  
                  
                  3,165,550
                  
                  
                  
                  3,415,117TOTAL
      ASSETS
                  
                  $
                  7,235,571
                  
                  
                  $
                  10,633,069LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
                  
                  $
                  345,762
                  
                  
                  $
                  155,051Accrued
      expenses
                  
                  
                  88,081
                  
                  
                  
                  12,463Total
      liabilities
                  
                  
                  433,843
                  
                  
                  
                  167,514COMMITMENTSSTOCKHOLDERS’
      EQUITYUndesignated
      capital stock, undesignated par value, 22,750,000 shares authorized at
      December 31, 2008 and 2007, none issued
                  
                  
                  -
                  
                  
                  
                  -Series
      A Convertible Preferred Stock, $.01 par value:Authorized
      - 2,250,000 shares at December 31, 2008 and 2007. Issued and outstanding 0
      and 2,000,000 shares, respectively
                  
                  
                  -
                  
                  
                  
                  20,000Common
      stock, $.01 par value:Authorized
      — 100,000,000 sharesIssued
      and outstanding—68,613,598 and 58,992,994 shares at December 31, 2008 and
      2007, respectively
                  
                  
                  686,136
                  
                  
                  
                  589,929Additional
      paid-in capital
                  
                  
                  17,835,865
                  
                  
                  
                  16,430,997Accumulated
      deficit
                  
                  
                  (11,720,273
                  )
                  
                  
                  (6,575,371
                  )TOTAL
      STOCKHOLDERS’ EQUITY
                  
                  
                  6,801,728
                  
                  
                  
                  10,465,555TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                  
                  $
                  7,235,571
                  
                  
                  $
                  10,633,069





See
accompanying notes to the consolidated financial statements


33





SpectraScience,
Inc. and Subsidiary


Consolidated
Statements of Operations


For the
Years Ended December 31, 2008 and 2007





Year Ended
                    December 31,2008
                  
                  
                  2007Revenue
                  
                  $
                  60,560
                  
                  
                  $
                  -Cost
      of revenue
                  
                  
                  27,130
                  
                  
                  
                  -Gross
      profit
                  
                  
                  33,430Operating
      expenses:Research
      and development
                  
                  
                  2,220,007
                  
                  
                  
                  796,944General
      and administrative
                  
                  
                  2,280,867
                  
                  
                  
                  1,634,109Sales
      and marketing
                  
                  
                  803,888
                  
                  
                  
                  589,535Total
      operating expenses
                  
                  
                  5,304,762
                  
                  
                  
                  3,020,588Operating
      loss
                  
                  
                  (5,271,332
                  )
                  
                  
                  (3,020,588
                  )Other
      income, net
                  
                  
                  126,430
                  
                  
                  
                  46,003Net
      loss
                  
                  
                  (5,144,902
                  )
                  
                  
                  (2,974,585
                  )Deemed
      dividend on preferred stock
                  
                  
                  -
                  
                  
                  
                  (1,000,000
                  )Net
      loss applicable to common stockholders
                  
                  $
                  (5,144,902
                  )
                  
                  $
                  (3,974,585
                  )Basic
      and diluted net loss per share
                  
                  $
                  (0.08
                  )
                  
                  $
                  (0.10
                  )Weighted
      average common shares outstanding
                  
                  
                  66,344,469
                  
                  
                  
                  41,699,789





See
accompanying notes to the consolidated financial statements


34





SpectraScience,
Inc. and Subsidiary


Consolidated
Statements of Stockholders’ Equity


For the
Year’s Ended December 31, 2008 and 2007




Preferred Stock
                    
                    
                    Common Stock
                    
                    
                    Additional
                      Paid-In
                    
                    
                    Deficit
                    
                    
                    Total
                      Stockholders’Shares
                    
                    
                    Amount
                    
                    
                    Shares
                    
                    
                    Amount
                    
                    
                    Capital
                    
                    
                    Accumulated
                    
                    
                    EquityBalance,
      December 31, 2006
                    
                    
                    
                    
                    
                    
                    
                    
                    38,370,087
                    
                    
                    $
                    383,701
                    
                    
                    $
                    2,742,888
                    
                    
                    $
                    (2,600,786
                    )
                    
                    $
                    525,803Stock
      based compensation - consultants
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    571,767
                    
                    
                    
                    
                    
                    
                    
                    571,767Stock
      based compensation - employees
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    829,329
                    
                    
                    
                    
                    
                    
                    
                    829,329Stock
      options exercised
                    
                    
                    
                    
                    
                    
                    
                    
                    10,000
                    
                    
                    
                    100
                    
                    
                    
                    1,400
                    
                    
                    
                    
                    
                    
                    
                    1,500Issuance
      of common stock at $0.50 per share
                    
                    
                    
                    
                    
                    
                    
                    
                    2,270,000
                    
                    
                    
                    22,700
                    
                    
                    
                    1,112,300
                    
                    
                    
                    
                    
                    
                    
                    1,135,000Issuance
      of preferred stock and warrants at $0.50 per share, net of
      expenses
                    
                    
                    2,000,000
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    973,021
                    
                    
                    
                    
                    
                    
                    
                    973,021Deemed
      dividend on preferred stock
                    
                    
                    
                    
                    
                    $
                    20,000
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    980,000
                    
                    
                    
                    (1,000,000
                    )Issuance
      of common stock for the assets of LUMA Imaging Corp.
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    11,200,000
                    
                    
                    
                    112,000
                    
                    
                    
                    4,912,783
                    
                    
                    
                    
                    
                    
                    
                    5,024,783Sale
      of common stock at $0.70 per share
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    7,142,857
                    
                    
                    
                    71,428
                    
                    
                    
                    4,307,509
                    
                    
                    
                    
                    
                    
                    
                    4,378,937Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (2,974,585
                    )
                    
                    
                    (2,974,585
                    )Balance,
      December 31, 2007
                    
                    
                    2,000,000
                    
                    
                    $
                    20,000
                    
                    
                    
                    58,992,944
                    
                    
                    $
                    589,929
                    
                    
                    $
                    16,430,997
                    
                    
                    $
                    (6,575,371
                    )
                    
                    $
                    10,465,555Stock
      based compensation – consultants
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    51,955
                    
                    
                    
                    
                    
                    
                    
                    51,955Stock
      based compensation – employees
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    940,268
                    
                    
                    
                    
                    
                    
                    
                    940,268Stock
      options exercised
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    20,000
                    
                    
                    
                    200
                    
                    
                    
                    2,800
                    
                    
                    
                    
                    
                    
                    
                    3,000Sale
      of common stock  at $0.70 per share
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    736,856
                    
                    
                    
                    7,369
                    
                    
                    
                    437,983
                    
                    
                    
                    
                    
                    
                    
                    445,352Conversion
      of Series A Preferred Stock
                    
                    
                    (2,000,000
                    )
                    
                    
                    (20,000
                    )
                    
                    
                    8,000,000
                    
                    
                    
                    80,000
                    
                    
                    
                    (60,000
                    )
                    
                    
                    
                    
                    
                    
                    -Conversion
      of Series A Preferred Stock Warrants
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    753,798
                    
                    
                    
                    7,538
                    
                    
                    
                    (7,538
                    )
                    
                    
                    
                    
                    
                    
                    -Common
      Stock issued for Services
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    110,000
                    
                    
                    
                    1,100
                    
                    
                    
                    39,400
                    
                    
                    
                    
                    
                    
                    
                    40,500Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (5,144,902
                    )
                    
                    
                    (5,144,902
                    )Balance,
      December 31, 2008
                    
                    
                    -
                    
                    
                    $
                    -
                    
                    
                    
                    68,613,598
                    
                    
                    $
                    686,136
                    
                    
                    $
                    17,835,865
                    
                    
                    $
                    (11,720,273
                    )
                    
                    $
                    6,801,728




See
accompanying notes to the consolidated financial statements


35





SpectraScience,
Inc. and Subsidiary


Consolidated
Statements of Cash Flows


For the
years ended December 31, 2008 and 2007





Year Ended December 31,2008
                
                
                2007OPERATING
      ACTIVITIES:Net
      loss
                
                $
                (5,144,902
                )
                
                $
                (2,974,585
                )Adjustments
      to reconcile net loss to cash used in operating
activities:Depreciation
      and amortization
                
                
                281,594
                
                
                
                57,198Stock-based
      compensation employees
                
                
                940,268
                
                
                
                829,329Stock-based
      compensation consultants
                
                
                51,955
                
                
                
                571,767Gain
      on disposal of fixed assets
                
                
                -
                
                
                
                (7,150
                )Fair
      market value of common stock issued for services
                
                
                40,500
                
                
                
                -Changes
      in operating assets and liabilities:Accounts
      receivable
                
                
                (23,877
                )
                
                
                -Inventory
                
                
                (179,172
                )
                
                
                -Prepaid
      expenses and other assets
                
                
                (43,907
                )
                
                
                (36,909
                )Accounts
      payable
                
                
                190,711
                
                
                
                97,362Accrued
      compensation and taxes
                
                
                75,618
                
                
                
                3,177Net
      cash used in operating activities
                
                
                (3,811,212
                )
                
                
                (1,459,811
                )INVESTING
      ACTIVITIES:Acquisition
      of fixed assets
                
                
                (207,136
                )
                
                
                (22,422
                )Proceeds
      from the sale of assets
                
                
                -
                
                
                
                7,150Net
      cash used in investing activities
                
                
                (207,136
                )
                
                
                (15,272
                )FINANCING
      ACTIVITIES:Net
      proceeds from issuance of common stock
                
                
                445,352
                
                
                
                5,513,937Net
      proceeds from issuance of preferred stock
                
                
                -
                
                
                
                973,021Proceeds
      from exercise of stock options
                
                
                3,000
                
                
                
                1,500Net
      cash provided by financing activities
                
                
                448,352
                
                
                
                6,488,458Net
      increase (decrease) in cash and cash equivalents
                
                
                (3,569,996
                )
                
                
                5,013,375CASH
      AND CASH EQUIVALENTS AT BEGINNING OF YEAR
                
                
                5,188,177
                
                
                
                174,802CASH
      AND CASH EQUIVALENTS AT END OF YEAR
                
                $
                1,618,181
                
                
                $
                5,188,177Supplemental
      disclosure of non-cash investing and financing activities:Issuance
      of common stock for assets of LUMA Imaging Corp.
                
                $
                -
                
                
                $
                5,024,783Reclassification
      of inventory to long-term assets
                
                $
                758,147
                
                
                $
                -





See
accompanying notes to the consolidated financial statements


36





SpectraScience,
Inc. and Subsidiary


Notes to
Consolidated Financial Statements




Note 1:
Organization and Description of Business





SpectraScience,
Inc. was incorporated in the State of Minnesota on May 4, 1983 as GV Medical,
Inc. In October 1992, GV Medical discontinued its prior business, refocused its
development efforts and changed its name to SpectraScience, Inc. The “Company”,
hereinafter, refers to SpectraScience, Inc. and its wholly owned subsidiary Luma
Imaging Corp. From 1996, the Company primarily focused on developing the WavSTAT
Optical Biopsy System (“WavSTAT System.”).





The
Company has developed and received FDA approval to market a proprietary,
minimally invasive technology that optically scans tissue in real-time to
distinguish between normal, pre-cancerous or cancerous cells without the need to
remove the subject cell tissue from the body to make such determinations. The
WavSTAT System operates by using cool, safe UV laser light to optically scan and
analyze tissue, enabling the physician to make an instant diagnosis during
endoscopy when screening for cancer, and if warranted, to begin immediate
treatment during the same procedure. The WavSTAT is FDA approved for colon
cancer detection.





On
November 6, 2007, the Company acquired the assets of Luma Imaging Corporation
(“LUMA”) in an equity transaction accounted for as an acquisition of assets and
now operates LUMA as a wholly owned subsidiary of the Company.   LUMA had
acquired the assets from a predecessor company that had developed, and received
FDA approval for, a non-invasive diagnostic imaging system that can detect
cervical cancer precursors and which utilizes an underlying technology that is
similar to that of the WavSTAT System. The addition of the LUMA technology to
the Company’s existing WavSTAT System technology provides the Company with a
broad suite of fluorescence-based intellectual property and know-how. LUMA
received FDA approval as an adjunct to colposcopy in March 2006.





To effect
the LUMA acquisition the Company issued 11,200,000 restricted common shares
valued at approximately $5,000,000. The valuation of the consideration of the
approximate $5,000,000 was determined based on the underlying value of assets
received which totaled $5,024,783, or $0.45 per share. The Company received
assets including patents, inventory and equipment. The Company capitalized
$3,226,000 for the fair value of the 28 patents acquired. The capitalized
amounts were determined based upon a market-based forecast approach which
utilized comparable assumed royalty revenue streams over several possible
scenarios. Forecast cash flows were then discounted to present value to
determine valuation. Inventories and equipment acquired were determined to have
fair values of approximately $874,000 and $924,000, respectively.





In the
third fiscal quarter of 2008, the Company began selling its products and is no
longer a development stage company.





Note 2:
Going Concern





The
Company has recently begun marketing its products. As of December 31, 2008, the
Company had working capital of $1,759,440 and cash and cash equivalents of
$1,618,181. On January 30, 2009, the Company entered into a Common Stock
Purchase Agreement with Fusion Capital Fund II (See Note 12). Under the Purchase
Agreement, Fusion Capital is obligated, under certain conditions, to purchase
shares from us in an aggregate amount of $6.0 million from time to time over a
twenty-four (24) month period. However, if the Company does not receive these
funds in a timely manner, the Company may not be able to continue as a going
concern. The Company may not be able to find alternative capital or raise
capital or debt on terms that are acceptable. Management believes that if the
Fusion Capital Agreement occurs as expected, such proceeds will be sufficient to
allow the Company to sustain operations until it attains profitability and
positive cash flows from operations. However, the Company may incur unknown
expenses, or the Company may not be able to meet the revenue forecasts which
will require the Company to seek additional capital. In such event, the Company
may not be able to find such capital or raise capital or debt on terms that are
acceptable.





The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and satisfaction of liabilities in
the normal course of business. The financial statements do not include any
adjustments relating to the recoverability and classification of assets or the
amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern.


37





Note 3:
Significant Accounting Policies





Revenue
Recognition





We
recognize revenue, net of discounts, from sales of our medical devices and from
sales of disposable supplies related to our medical devices, when products have
been shipped, when title transfers, when the selling price is fixed or
determinable, and when collection of the resulting receivable is reasonably
assured. Terms of sale for sales are FOB origin, reflecting that title and risk
of loss are assumed by the purchaser at the shipping point.





Consolidation





The
accompanying consolidated financial statements include the accounts of
SpectraScience, Inc. and its wholly-owned subsidiary Luma Imaging Corp. All
significant intercompany balances and transactions have been eliminated in
consolidation.





Risks
and Uncertainties





The
Company operates in an industry that is subject to intense competition,
government regulation and rapid technological change. The Company's operations
are subject to significant risk and uncertainties including financial,
operational, technological, regulatory and other risks associated with a
development stage company, including the potential risk of business
failure.





Use
of Estimates





The
Company prepares its consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America, which
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and disclosures made in the accompanying
notes to the financial statements. Significant estimates made by management
include, among others, realization of long-lived assets, assumptions used to
value stock options, assumptions used to value the common stock issued and the
assets acquired in the Luma acquisition and the realization of intangible
assets. Actual results could differ from those estimates.




Cash
Equivalents




Highly
liquid investments with original maturities of three months or less when
purchased are considered to be cash equivalents. Financial instruments which
potentially subject the Company to concentrations of credit risk consist
primarily of cash and cash equivalents. The Company maintains its cash and cash
equivalents with high-credit quality financial institutions. At times, such
amounts may exceed insured limits. At December 31, 2008, the Company had no cash
balances in excess of insured limits. The Company has not experienced any losses
in such accounts and believes it is not exposed to any significant credit risk
on its cash equivalent accounts.





Stock-Based
Compensation





In
December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (“SFAS”), 123(R), “Share-Based Payment”, (“SFAS
123(R)”) which establishes standards for transactions in which an entity
exchanges its equity instruments for goods or services. SFAS 123(R) requires an
issuer to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award.
SFAS 123(R) became effective for the Company commencing January 1, 2006 using
the modified prospective method. The Company previously adopted the fair value
recognition provisions of SFAS 123 “Accounting for Stock-Based Compensation”
prospectively for all employee and consultant awards granted, modified, or
settled by the Successor Company on August 2, 2004. Accordingly, SFAS 123(R) has
not had a material impact on the Company’s consolidated financial
statements.




In
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
(“EITF”) No. 96-18, “Accounting for Equity Instruments That are Issued to Other
Than Employees for Acquiring or in Conjunction with Selling Goods of Services,”
all issuances of common stock, stock options or other equity instruments to
non-employees as the consideration for goods or services received by the Company
are accounted for based on the fair value of the equity instruments issued
(unless the fair value of the consideration received can be more reliably
measured). Any options issued to non-employees are recorded in expense and
additional paid-in capital in stockholders’ equity over the applicable service
periods through the vesting date based on the fair value of the options at the
end of each period.





For the
years ended December 31, 2008 and 2007, stock-based compensation was
approximately $992,000 and $1,401,000, respectively. In fiscal 2008, stock
option expense was approximately $430,000 for research and development, $495,000
in general and administration and $67,000 in sales and marketing. In fiscal
2007, stock option expense was approximately $162,000 in research and
development, $982,000 in general and administrative and $257,000 in sales and
marketing.


38





At
December 31, 2008, the Company has one stock-based employee compensation plan
(the “Option Plan"), which is described more fully in Note 7 of the consolidated
financial statements.





The fair
value of options granted were estimated at the date of grant using a
Black-Scholes option-pricing model which includes several variables including
expected life, risk free interest rate, expected stock price volatility, stock
option exercise patterns and expected dividend yield. The Company also must
estimate forfeitures for employee stock options. The following average
assumptions were used to value non-employee options in the past two years:




2008
                  
                  
                  2007Expected
      life
                  
                  5
      years
                  
                  
                  5
      yearsRisk-free
      interest rate
                  
                  
                  2.63
                  %
                  
                  
                  4.10
                  %Expected
      volatility
                  
                  
                  125
                  %
                  
                  
                  138
                  %Expected
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %




Management
used the following assumptions to value employee options over the past two
years:




2008
                  
                  
                  2007Expected
      life
                  
                  5
      years
                  
                  
                  5
      yearsRisk-free
      interest rate
                  
                  
                  2.21
                  %
                  
                  
                  4.00
                  %Expected
      volatility
                  
                  
                  123
                  %
                  
                  
                  138
                  %Expected
      dividend yield
                  
                  
                  0
                  %
                  
                  
                  0
                  %




In
addition to the above, management estimated the forfeitures on employee options
under the Option Plan would have negligible effects because such forfeitures
would be a very small percentage. Management believes that options granted have
been to a group of individuals that have a high desire to see the Company
succeed and have aligned themselves to that end.





The
expected lives used in the calculations were selected by management based on
past experience, forward looking profit forecasts and estimates of what the
trading price of the Company’s stock might be at different future dates.
Risk-free interest rates used are the 5-year U.S. Treasury rate as published for
the applicable measurement dates.





Volatility
is a calculation based on the Company’s stock price and volume as calculated
since the beginning of the Successor Company and becomes a risk-measurement
component included in the Black-Scholes calculation of estimated fair value.
Management computed and tested its volatility calculation for reasonableness and
found it to be acceptable based on a number of factors including the Company’s
current market capitalization and comparisons to other companies similar to
SpectraScience, Inc.





Patents





The
Company accounts for acquired intangible assets under SFAS No. 142, “Goodwill
and Other Intangible Assets” (“SFAS 142”). On August 2, 2004, at the inception
of the Successor Company, the Company capitalized $290,000 to value eight
WavSTAT System patents. On November 6, 2007, coincident with the acquisition of
the LUMA assets, the Company capitalized an additional $3,226,000 to value the
28 patents acquired. In both cases, the capitalized amounts were determined
based upon a market-based forecast approach which utilized comparable assumed
royalty revenue streams over several possible scenarios. These forecast cash
flows were then discounted to present value to determine valuation.





All
patents are amortized over the shorter of their remaining legal lives or
estimated economic lives. When acquired, the WavSTAT System patents had an
average remaining useful life of 14 years, while the LUMA patents had an average
remaining life of approximately 16 years. Amortization expense associated with
patents for the fiscal years ended December 31, 2008 and 2007 was $249,567 and
$53,945, respectively. Patents are reported net of accumulated amortization of
$350,450 and $100,883 at December 31, 2008 and 2007, respectively. Amortization
expense in each of the five years subsequent to December 31, 2008 is expected to
approximate $250,000 per year.




Research
and Development




Research
and development costs are expensed as incurred. There may be cases in the future
where certain research and development costs such as software development costs
are capitalized. For the years ended December 31, 2008 and 2007, research and
development costs were $2,220,007 and $796,944, respectively.


39





Accounts
Receivable





Receivables
are carried at original invoice amount less payment received and an estimate
made for doubtful receivables based on a review of all outstanding amounts on a
monthly basis. Receivables are generally considered past due 30 days after
payment date as specified on the invoice. We determine allowance for doubtful
accounts by regularly evaluating individual receivables and considering a
creditor’s financial condition, credit history and current economic conditions.
Receivables are written off when deemed uncollectible. Recoveries of previously
written off receivables previously written off are recorded when
received.





Inventories





Inventories
are valued at the lower of cost (using the first-in, first-out method) or market
value.




Fixed Assets





Fixed
assets are stated at cost less accumulated depreciation. Depreciation expense is
computed using the straight-line method over the estimated useful lives of the
related assets, which range from two to three years. For the years ended
December 31, 2008 and 2007, depreciation expense was $32,027 and $3,253,
respectively. Repairs and maintenance are charged to expense as incurred while
improvements are capitalized. Upon the sale, retirement or disposal of fixed
assets, the accounts are relieved of the cost and the related accumulated
depreciation with any gain or loss recorded to the consolidated statements of
operations. The fixed asset account balance at December 31, 2008 and 2007
includes approximately $1,837,000 and $924,000 of LUMA equipment and parts,
respectively. The LUMA equipment will be depreciated at the time the machines
are placed into service.





Fair
Value of Financial Instruments





The
carrying amount of the Company's cash and cash equivalents, accounts receivable,
accounts payable and accrued liabilities approximate their estimated fair values
due to the short-term maturities of those financial instruments.





Long-Lived
Assets





SFAS
No.144 “Accounting for the Impairment or Disposal of Long-Lived Assets”,
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets. SFAS 144 requires that long-lived assets be reviewed for
impairment whenever events or changes in circumstances indicate that their
carrying amounts may not be recoverable. If the cost basis of a long-lived asset
is greater than the projected future undiscounted net cash flows from such
asset, an impairment loss is recognized. Impairment losses are calculated as the
difference between the cost basis of an asset and its estimated fair value. SFAS
144 also requires companies to separately report discontinued operations and
extends that reporting requirement to a component of an entity that either has
been disposed of (by sale, abandonment or in a distribution to owners) or is
classified as held for sale. Assets to be disposed of are reported at the lower
of the carrying amount or the estimated fair value less costs to sell. The
Company believes no impairment exists at December 31, 2008.





Earnings
(Loss) Per Share





Under
SFAS No. 128 "Earnings Per Share", basic earnings (loss) per share is computed
by dividing net income (loss) available to common stockholders by the weighted
average number of common shares assumed to be outstanding during the period of
computation. Diluted earnings per share is computed similar to basic earnings
per share except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potential
common shares had been issued and if the additional common shares were dilutive.
For all periods presented, basic and diluted loss per share are the same, as any
additional common stock equivalents would be antidilutive. Potentially dilutive
shares of common stock that have been excluded from the calculation of the
weighted average number of dilutive common shares. For the year ended December
31, 2008, there were 525,000 additional potentially dilutive shares of common
stock. These additional shares include the common stock equivalent effect of
787,966 outstanding warrants and 8,150,000 options. For the year ended December
31, 2007, there were 11,486,658 additional potentially dilutive shares of common
stock due primarily to the effect of outstanding convertible preferred stock and
stock options.





Income
Taxes





Income
taxes are provided for the tax effects of transactions reported in the
consolidated financial statements and consist of taxes currently due plus
deferred income taxes. Deferred income taxes are recognized for temporary
differences between the financial statement and tax bases of assets and
liabilities that will result in taxable or deductible amounts in the future.
Deferred income taxes are also recognized for net operating loss carryforwards
that are available to offset future taxable income and research and development
credits. Valuation allowances are established when necessary to reduce deferred
tax assets to the amount expected to be realized.


40





In July
2006, the Financial Accounting Standards Board issued Financial Interpretation
No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”, which applies
to all tax positions related to income taxes subject to SFAS 109, “Accounting
for Income Taxes”. FIN 48 requires a new evaluation process for all tax
positions taken. If the probability for sustaining said tax position is greater
than 50%, then the tax position is warranted and recognition should be at the
highest amount which would be expected to be realized upon ultimate settlement.
FIN 48 requires expanded disclosure at each annual reporting period unless a
significant change occurs in an interim period. Differences between the amounts
recognized in the statements of financial position prior to the adoption of FIN
48 and the amounts reported after adoption are to be accounted for as an
adjustment to the beginning balance of retained earnings. The Company has
completed its initial evaluation and implementation of the impact of the January
1, 2007 adoption of FIN 48 and determined that the Company does not have
uncertain tax positions on its 2004, 2005, 2006 and 2007 tax returns. Based on
evaluation of the 2008 transactions and events, the Company does not have any
material uncertain tax positions that require measurement. Because the Company
had a full valuation allowance on its deferred tax assets as of December 31,
2008 and 2007, the Company has not recognized any tax benefits since
inception.





Our
policy is to recognize interest and/or penalties related to income tax matters
in income tax expense. We had no accrual for interest or penalties on our
consolidated balance sheets at December 31, 2008 or 2007, and have not
recognized interest and/or penalties in the consolidated statement of operations
for the years ended December 31, 2008 or 2007.





We are
subject to taxation in the US and the state of California. All of our tax years
are subject to examination by the US and California tax authorities due to the
carryforward of unutilized net operating losses.




Recent
Accounting Pronouncements





In June
2008, the Emerging Issues Task Force (EITF) ratified a consensus on EITF Issue
No. 07-05, “Determining Whether an Instrument (or Embedded Feature) is Indexed
to an Entity’s Own Stock” which provides guidance for determining whether an
equity-linked financial instrument (or embedded feature) is indexed to an
entity’s own stock. EITF Issue No. 07-5 provides for a two-step approach for the
evaluation of a financial instrument’s contingent exercise and settlement
provisions to determine if the instrument is indexed to an entity’s own stock.
The Task Force reached a consensus that this Issue should be effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and interim periods within those fiscal years. Early application is not
permitted. The Company had no instruments subject to EITF Issue No. 07-05 on
December 31, 2008.





In
December 2007, the FASB issued No. 141(R), “Business Combinations” (“SFAS
141(R)”). SFAS 141(R) replaces SFAS 141 and provides greater consistency in the
accounting and financial reporting of business combinations. SFAS 141(R)
requires the acquiring entity in a business combination to recognize all assets
acquired and liabilities assumed in the transaction and any non-controlling
interest in the acquiree at the acquisition date and be measured at the fair
value as of that date. This includes the measurement of the acquirer’s shares
issued in consideration for a business combination, the recognition of
contingent consideration, the accounting for pre-acquisition gain and loss
contingencies, the recognition of capitalized in-process research and
development, the accounting for acquisition related restructuring cost accruals,
the treatment of acquisition related transaction costs and the recognition of
changes in the acquirer’s income tax valuation allowance and deferred taxes.
SFAS 141(R) will be effective for the Company on January 1, 2009 and is to
be applied prospectively. Early adoption is not permitted. Management is
currently assessing the impact, if any, that SFAS 141(R) may have on the
Company.





In
November 2007, the Emerging Issues Task Force (EITF) ratified a consensus on
EITF Issue No. 07-1, “Accounting for Collaborative Arrangements” (“EITF
07-1”) which requires participants in a collaboration to make separate
disclosures regarding the nature and purpose of an arrangement, their rights and
obligations under the arrangement, the accounting policy for the arrangement and
the income statement classification and amounts arising from the arrangement
between participants for each period an income statement is presented. EITF 07-1
is effective for us beginning in the first quarter of fiscal year 2009. We are
currently evaluating the impact of the provisions of EITF 07-1 on our financial
position, results of operations and cash flows and therefore, the impact of the
adoption is unknown at this time.




In June
2007, the EITF ratified a consensus on EITF Issue No. 07-3 (“EITF 07-3”),
“Accounting for Non-Refundable Advance Payments for Goods or Services to Be Used
in Future Research and Development Activities,” which concluded that
non-refundable advance payments for goods or services for use in research and
development activities should be deferred and capitalized. EITF 07-3 is
effective for us beginning in the first quarter of fiscal year 2008. We are
currently evaluating the impact of the provisions of EITF 07-3 on our financial
position, results of operations and cash flows and therefore, the impact of the
adoption is unknown at this time.





Other
accounting standards that may have been issued or proposed by the FASB or other
standards-setting bodies have had no significantl impact on the Company’s
consolidated financial statements.


41





Note 4:
Inventories





Inventories
consisted of the following at December 31, 2008 and 2007,
respectively:





December 31,2008
                        
                        
                        2007Raw
      Materials
                        
                        $
                        205,651
                        
                        
                        $
                        986,740Finished
      Goods
                        
                        
                        260,230
                        
                        
                        
                        58,116Total
      inventories
                        
                        $
                        465,881
                        
                        
                        $
                        1,044,856




Note 5:
Income Taxes





The
significant components of deferred tax assets as of December 31, 2008 and 2007
are shown below. A valuation allowance has been established to offset the
deferred tax assets, as realization of such assets is uncertain.





Year Ended
                    December 31,
                    2008
                  
                  
                  Year Ended
                    December 31,
                    2007Deferred
      tax assets:Net
      operating loss carryforward
                  
                  $
                  10,678,283
                  
                  
                  $
                  10,350,300Research
      and development credits
                  
                  
                  634,274
                  
                  
                  
                  565,200Stock
      compensation
                  
                  
                  1,221,793
                  
                  
                  
                  831,700Accrued
      liabilities and other
                  
                  
                  26,085
                  
                  
                  
                  17,600Total
      deferred tax assets
                  
                  
                  12,560,435
                  
                  
                  
                  11,764,800Valuation
      allowance
                  
                  
                  (10,589,131
                  )
                  
                  
                  (9,687,800
                  )Net
      deferred tax assets
                  
                  
                  1,971,304
                  
                  
                  
                  2,077,000Deferred
      tax liabilities:Acquired
      intangibles
                  
                  
                  (81,348
                  )
                  
                  
                  (89,000
                  )Fixed
      assets
                  
                  
                  (710,326
                  )
                  
                  
                  -Patents
                  
                  
                  (1,179,630
                  )
                  
                  
                  -Luma
      asset acquisition with common stock
                  
                  
                  -
                  
                  
                  
                  (1,988,000
                  )Total
      deferred tax liabilities
                  
                  
                  (1,971,304
                  )
                  
                  
                  (2,077,000
                  )Net
      deferred taxes
                  
                  $
                  -
                  
                  
                  $
                  -






The
following reconciles the tax provision with the expected provision obtained by
applying statutory rates to pretax income:





Year Ended December 31, 2008
                                                  
                                                  Year Ended December 31, 2007Amount
                                                  
                                                  % of Pretax
                                                    Income
                                                  
                                                  Amount
                                                  
                                                  % of Pretax
                                                    IncomeIncome
      tax at federal statutory rate
                                                  
                                                  $
                                                  (1,750,000
                                                  )
                                                  
                                                  34.0
                                                  %
                                                  $
                                                  (1,011,000
                                                  )
                                                  
                                                  34.0
                                                  %State
      tax provision, net of federal tax benefit
                                                  
                                                  
                                                  (300,000
                                                  )
                                                  
                                                  5.8
                                                  
                                                  
                                                  (174,000
                                                  )
                                                  
                                                  5.8Nondeductible
      differences
                                                  
                                                  
                                                  28,000
                                                  
                                                  
                                                  (0.5
                                                  )
                                                  
                                                  22,000
                                                  
                                                  
                                                  (0.7
                                                  )Tax
      credits
                                                  
                                                  
                                                  (55,000
                                                  )
                                                  
                                                  1.1
                                                  
                                                  
                                                  (23,000
                                                  )
                                                  
                                                  0.8Change
      in valuation allowance
                                                  
                                                  
                                                  901,000
                                                  
                                                  
                                                  (17.5
                                                  )
                                                  
                                                  1,180,000
                                                  
                                                  
                                                  (39.7
                                                  )Expiration
      of net operating losses
                                                  
                                                  
                                                  1,056,000
                                                  
                                                  
                                                  (20.5
                                                  )
                                                  
                                                  -
                                                  
                                                  
                                                  -Other
                                                  
                                                  
                                                  120,000
                                                  
                                                  
                                                  (2.3
                                                  )
                                                  
                                                  6,000
                                                  
                                                  
                                                  (0.2
                                                  )Provision
      for income taxes
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  0.0
                                                  %
                                                  $
                                                  -
                                                  
                                                  
                                                  0.0
                                                  %





At
December 31, 2008, the Company had Federal net operating loss carry-forwards of
approximately $26,496,000 that expire from 2009 through 2028. During 2008, the
Company had federal net operating losses of approximately $2,683,000
expire.  In addition, the Company had  research and development
tax credits of approximately $607,000 that expire from 2012 through 2028.
As a result of previous stock transactions, the Company's ability to utilize its
net operating loss carryforwards to offset future taxable income and utilize
future research and development tax credits is subject to certain limitations
under Section 382 and Section 383 of the Internal Revenue Code due to changes in
equity ownership of the Company.


42





The
Company has a history of operating losses and, as of yet, has not had any
taxable income. The company has calculated a deferred tax asset for its tax
credits but offsets the tax asset with a valuation allowance. As a result, the
Company has not realized or recorded any tax benefit related to its tax
credits.





Note 6:
Lease Commitment





The
Company leases its principal facility from an unrelated third party. The
facility consists of approximately 5,080 square feet of office, research and
development, manufacturing, quality testing, and warehouse space. The lease
provides for monthly rental payments of $5,334 through December 2009. Total
commitment under this lease for 2009 is approximately $64,000. For the years
ended December 31, 2008 and 2007, rent expense totaled $97,873 and $43,300,
respectively.





Note 7:
Stock-Based Compensation Plans





The 2001
stock option plan (the “Option Plan”) was amended in 2004. The Option Plan
provides for the grant of incentive stock options (“ISOs") to our full-time
employees (who may also be Directors) and nonqualified stock options ("NSOs") to
non-employee directors, consultants, customers, vendors or providers of
significant services and expires on January 30, 2011. The exercise price of any
ISO may not be less than the fair market value of the common stock on the date
of grant and the term shall not exceed ten years. The amount reserved under the
Plan shall equal 15% of the outstanding shares of the Company totaling
10,292,040 at December 31, 2008. At December 31, 2008, the Company had granted
8,150,000 options under the Plan (4,216,667 of which are exercisable), with
2,142,040 available for future issuance.





Options
outstanding that have vested and are expected to vest as of December 31, 2008
are as follows:





Number of
                Shares
              
              Weighted
                AverageExercise
                Price
              
              Weighted Average
                Remaining
                Contractual Term in
                Years
              
              Aggregate
                Intrinsic
                Value (1)Vested
              
              
              4,216,667
              
              $
              0.64
              
              
              7.29
              
              $
              -Expected
      to vest
              
              
              3,933,333
              
              $
              0.53
              
              
              9.55
              
              
              -Total
              
              
              8,150,000
              
              
              
              
              
              
              
              $
              -




(1) These
amounts represent the difference, if any, between the exercise price and $0.24,
the closing market price of the Company’s common stock on December 31, 2008 as
quoted on the Over-the-Counter Board under the symbol “SCIE.OB”.





Additional
information with respect to stock option activity is as follows:




Outstanding OptionsOptions
                                                      Available For
                                                      Grant
                                                    
                                                    
                                                    Plan Options
                                                      Outstanding
                                                    
                                                    
                                                    Weighted
                                                      Average
                                                      Exercise Price
                                                      Per Share
                                                    
                                                    Weighted-Average
                                                      Remaining
                                                      Contractual Term
                                                      (years)
                                                    
                                                    Aggregate
                                                      Intrinsic
                                                      Value (1)December
      31, 2006
                                                    
                                                    
                                                    3,281,114
                                                    
                                                    
                                                    
                                                    2,330,000
                                                    
                                                    
                                                    $
                                                    0.42Options
      granted
                                                    
                                                    
                                                    (3,552,000
                                                    )
                                                    
                                                    
                                                    3,552,000
                                                    
                                                    
                                                    $
                                                    0.89Options
      exercised
                                                    
                                                    
                                                    10,000
                                                    
                                                    
                                                    
                                                    (10,000
                                                    )
                                                    
                                                    $
                                                    0.15Options
      forfeited
                                                    
                                                    
                                                    77,000
                                                    
                                                    
                                                    
                                                    (77,000
                                                    )
                                                    
                                                    $
                                                    0.85Additional
      options authorized
                                                    
                                                    
                                                    3,237,828December
      31, 2007
                                                    
                                                    
                                                    3,053,942
                                                    
                                                    
                                                    
                                                    5,795,000
                                                    
                                                    
                                                    $
                                                    0.70Options
      granted
                                                    
                                                    
                                                    (3,050,000
                                                    )
                                                    
                                                    
                                                    3,050,000
                                                    
                                                    
                                                    $
                                                    0.42Options
      exercised
                                                    
                                                    
                                                    20,000
                                                    
                                                    
                                                    
                                                    (20,000
                                                    )
                                                    
                                                    $
                                                    0.15Options
      forfeited
                                                    
                                                    
                                                    675,000
                                                    
                                                    
                                                    
                                                    (675,000
                                                    )
                                                    
                                                    $
                                                    0.89Additional
      options authorized
                                                    
                                                    
                                                    1,443,098
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    $December
      31, 2008
                                                    
                                                    
                                                    2,142,040
                                                    
                                                    
                                                    
                                                    8,150,000
                                                    
                                                    
                                                    $
                                                    0.58
                                                    
                                                    9.55
                                                    
                                                    $
                                                    -Exercisable
      December 31, 2008
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    4,216,667
                                                    
                                                    
                                                    $
                                                    0.64
                                                    
                                                    7.29
                                                    
                                                    $
                                                    -


43




The total
intrinsic value of options exercised during the years ended December 31, 2008
and 2007 was $13,000 and $10,700, respectively. At December 31, 2008, total
unrecognized estimated employee and director compensation cost related to
non-vested stock options granted prior to that date is $1,605,130, which is
expected to be recognized over approximately 3 years.





For the
fiscal year ended December 31, 2008, the Company granted stock options to
purchase 3,050,000 common shares to employees and directors. At the time of
grant, those options were estimated to have an aggregate fair value of
approximately $1,070,000. For the fiscal year ended December 31, 2007, the
Company granted stock options to purchase 2,341,667 common shares to employees
and directors. At the time of grant, these options were estimated to have an
aggregate fair value of approximately $2,005,000.





Note 8:
Undesignated Capital Stock





The
Company authorized 25,000,000 of undesignated shares of capital stock with
undesignated par value. On June 12, 2007, the Company’s Articles of
Incorporation were amended to designate 2,250,000 of the Company’s undesignated
capital stock as Series A Convertible Preferred Stock (the “Preferred”) with par
value of $0.01 per share. On December 31, 2008 there remained 22,750,000
undesignated shares of capital stock. The undesignated stock may be issued in
one or more series as determined from time to time by the Board of Directors.
Any series authorized for issuance by the Board of Directors may be senior to
the common stock with respect to any distribution if so designated by the Board
of Directors upon issuance of the shares of that series. The Board of Directors
are granted the express authority to fix by resolution any other designations,
powers, preferences, rights (including voting rights), qualifications,
limitations or restrictions with respect to any particular series created from
the undesignated stock prior to issuance thereof.





Note 9:
Equity Transactions





Fiscal
Year Ended December 31, 2008





Common
Stock





In
December 2008, the Company issued 100,000 restricted common shares to Fusion
Capital in payment of expenses related to a proposed financing. The fair value
of the shares was determined to be, and the company capitalized an amount of
$33,000, based upon the market value of the stock on the date of issuance. This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





In June
2008, the Company issued 10,000 restricted common shares to a vendor for
services. The fair value of the shares was determined to be $7,500, and the
company recognized expense in the amount of $7,500, based upon the market value
of the stock on the date of issuance.





In May
2008, the Company issued 121,470 shares of Common Stock to accredited investors
at a price of $0.70 per share for an aggregate consideration of $85,000 in the
final closing tranche of the Financing. The Company received net cash proceeds
of approximately $68,000 after placement agent commissions and expenses of
approximately $17,000. This transaction was exempt from the registration
requirements of the Securities Act of 1933 pursuant to Regulation D promulgated
under the Securities Act of 1933.





In
February 2008, the Company issued 615,386 shares of Common Stock to accredited
investors at a price of $0.70 per share for an aggregate consideration of
$430,770. The Company received net cash proceeds of approximately $377,000 after
placement agent commissions and expenses of $42,770. This transaction was exempt
from the registration requirements of the Securities Act of 1933 pursuant to
Regulation D promulgated under the Securities Act of 1933.





Series
A Convertible Preferred Stock





In March
2008, the holder of 2,000,000 shares of Series A Convertible Preferred stock
converted his shares into 8,000,000 shares of restricted Common Stock. The
Series A Convertible Preferred Stock was converted into Common Stock at a
conversion price of $0.125 per share. The Company received no proceeds as a
result of the transaction.  This transaction was exempt from the
registration requirements of the Securities Act of 1933 pursuant to Regulation D
promulgated under the Securities Act of 1933.





Series
A Convertible Preferred Stock Warrants





In
December 2008 the holders of 71,250 of the Company’s Series A Preferred Warrants
effected a cashless exercise of their warrants in exchange for 147,981
restricted common shares. The Company received no proceeds as a result of the
exercise. This transaction was exempt from the registration requirements of the
Securities Act of 1933 pursuant to Regulation D promulgated under the Securities
Act of 1933.


44





In May
2008 the holders of 153,750 of the Company’s Series A Preferred Warrants
effected a cashless exercise of their warrants in exchange for 521,249
restricted common shares. The Company received no proceeds as a result of the
exercise. This transaction was exempt from the registration requirements of the
Securities Act of 1933 pursuant to Regulation D promulgated under the Securities
Act of 1933.





In April
2008 a holder of 25,000 of the Company’s Series A Preferred Warrants effected a
cashless exercise of his warrants in exchange for 84,568 restricted common
shares. The Company received no proceeds as a result of the exercise. This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





Common
Stock Purchase Warrants





In May
2008, as additional consideration associated with a private placement of Common
Stock, the Company issued 73,681 five-year cashless warrants to purchase an
equal number of common shares at $0.80 per share to Advanced Equities, Inc., the
placement agent associated with the placement. The Company is obligated to
reserve 73,681 common shares under these warrants and the shares underlying the
warrants are subject to a registration rights agreement. This transaction was
exempt from the registration requirements of the Securities Act of 1933 pursuant
to Regulation D promulgated under the Securities Act of 1933.





Stock
Options





In May
2008, 20,000 stock options held by an employee were exercised. The Company
received net proceeds of $3,000 as a result of the exercise.





Fiscal
Year Ended December 31, 2007





Common
Stock





In
December 2007, the Company issued 7,142,857 shares of Common Stock to accredited
investors at a price of $0.70 per share. The Company received net cash of
approximately $4,379,000 after placement agent commissions and expenses of
$600,000 and other transaction expenses of approximately $21,000. This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





In
November 2007, the Company issued 11,200,000 shares of restricted Common Stock
to accredited investors in exchange for the assets of LUMA Imaging Corporation.
The price paid was based on the fair-value of the underlying assets received,
which totaled approximately $5,025,000 or $0.45 per share. This transaction was
exempt from registration pursuant to Section 4(2) promulgated under the
Securities Act of 1933.





From
March through May of 2007, the Company issued 2,270,000 shares of Common Stock
at a price of $0.50 per share to accredited investors for $1,135,000 in cash.
This transaction was exempt from the registration requirements of the Securities
Act of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





Series
A Convertible Preferred Stock





On June
12, 2007, the Company’s Articles of Incorporation were amended to designate
2,250,000 of the Company’s undesignated capital stock as Series A Convertible
Preferred Stock (the “Preferred”) with par value $0.01 per share. At issuance,
the Preferred is convertible into an equal number of shares of the Company’s
common stock based upon an initial conversion price of $.50 per share and
carries a liquidation preference of like amount. On December 31, 2007, the
Preferred conversion price reset to $0.125 per share based upon the inability of
the Company to attain certain revenue levels through that date. In addition, the
Preferred has rights which provide for (i) dividend payments senior to those
with respect to common shares, (ii) voting rights equal to the number of common
shares into which the Preferred is convertible, (iii) automatic conversion in
the event either of an underwritten public offering exceeding $30 million in
gross proceeds to the Company at an offering price in excess of $2.00 per share
or approval of 67% of the Preferred holders and (iv) adjustments to the
conversion price in the event of stock dividends, stock splits or other
effective stock subdivisions. If the Company declares a dividend or a
distribution on any common stock of the Company, the Company shall pay a
dividend or make a distribution on all outstanding shares of Preferred in an
amount per share equal to the maximum amount paid or set aside for all shares of
common stock into which each such share of Preferred could then be converted. On
June 15, 2007, the Company sold 2,000,000 shares of its Preferred, to three
accredited investors for gross proceeds of $1,000,000 in cash. As additional
consideration for the purchase of the Preferred, the Company issued five-year
warrants to purchase 250,000 additional shares of Preferred at an initial
exercise price of $0.50 per share. The Company is also required to reserve
250,000 shares of Preferred for issuance in relation to the
warrants.


45




The
convertible feature of the Preferred and the terms of the warrants provide for a
rate of conversion or exercise that was below market value at issuance. Such
feature, as it specifically relates to the convertible feature of the Preferred,
is characterized as a "Beneficial Conversion Feature" ("BCF"). Pursuant to EITF Issue No.
98-5, "Accounting for Convertible Securities with Beneficial Conversion Features
or Contingently Adjustable Conversion Ratios" (“EITF 98-5”) and EITF No. 00-27,
"Application of EITF Issue No. 98-5 to Certain Convertible Instruments," the
estimated relative fair values of the Preferred and the warrants, in approximate
amounts of $782,000 and $218,000, respectively, were calculated assuming the
most favorable conversion price determinable to the Preferred shareholders. The
value of the BCF was determined by the intrinsic value method and the fair value
of the warrants was determined by the Black-Scholes option-pricing model at the
date of issuance. The warrant fair value was determined assuming a five-year
term, stock volatility of 140%, and a risk-free interest rate of 5.10%. The
stand-alone fair value of the BCF was determined to be substantially higher than
the proceeds received and, accordingly, the value assigned to the BCF was
limited to the gross proceeds received from the offering. Per the guidance of
EITF 98-5, the value of the BCF and warrants are treated as a deemed dividend to
the Preferred stockholders and, due to the potential immediate convertibility of
the Preferred stock at issuance, is recorded as an increase to both additional
paid-in-capital and deficit accumulated at the time of issuance.





Series
A Convertible Preferred Stock Purchase Warrants





In June
2007, the Company issued five-year warrants to accredited investors to purchase
250,000 shares of Series A Preferred at $0.50 per share.  This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.





Common
Stock Purchase Warrants





In
December 2007, the Company issued 714,285 five-year warrants to purchase Common
Stock at $0.80 per share to Advanced Equities, Inc., the Placement Agent
associated with the December private equity financing.  This
transaction was exempt from the registration requirements of the Securities Act
of 1933 pursuant to Regulation D promulgated under the Securities Act of
1933.




Stock Options
  From March through June of 2007, an employee
exercised stock options to acquire 10,000 common shares for an aggregate
purchase price of $1,500.




Note 10:
Related Party Transactions




In June
2007, a director of the Company, Mr. John Pappajohn, coincident with his
becoming a director purchased $925,000 of the Company’s Series A Preferred
Stock. As an inducement to engage in the Preferred transaction Mr. Pappajohn
also received 213,250 warrants to purchase an equal number of Preferred shares
at a conversion price of $0.50 per share. Also coincident with becoming a
director, Mr. Pappajohn was granted a stock option to purchase 400,000 shares of
common stock at an exercise price of $1.10 which, at the time of grant, was
determined to have a fair value of approximately $394,000. On December 31, 2007,
Mr. Pappajohn invested an additional $383,000 and purchased 547,142 shares of
unregistered common stock as a part of the initial closing of the Company’s
Regulation D private placement offering. In March 2008, pursuant to the terms of
the Certificate of Designation of the Series A Preferred Stock, Mr. Pappajohn
and related entities converted Preferred Stock into 8,000,000 shares of
restricted common stock.





In
November 2007, coincident with the Company’s purchase of the assets of Luma
Imaging Corporation for 11,200,000 shares of restricted common stock, the
related entities of Euclid SR Partners, LP, Euclid SR Biotechnology Partners LP
and Euclid Partners IV, LP (“Euclid”) received 9,968,000 of the restricted
common stock shares issued. This stock had an estimated fair value of $4,984,000
at the time of acquisition. On December 31, 2007, Euclid purchased an additional
357,142 shares of common stock for $250,000 as a part of the initial closing of
the Company’s Regulation D private placement offering. The Company had no
relationship with Euclid Partners, or any of Euclid’s affiliates, prior to the
acquisition. The nature of the Company’s relationship arose out of and exists
solely as a result of the acquisition and had no effect on our accounting for
the transaction.





On
November 7, 2008, the Board of Directors approved the grant of 400,000 options
to non-employee directors Messrs. Mulford, McWilliams, Pappelbaum and
Sievert.  The terms are as follows: 1/3 of the grant will vest after
one year and the remaining options will vest an additional 1/3 over each of the
next three years.  The options were granted at the closing price of
our Common Stock on the date of grant.





Note 11:
License Agreement





The
Company is the exclusive licensee through the Massachusetts General Hospital of
US Patent number 5,843,000 entitled, “Optical Biopsy Forceps and Method of
Diagnosing Tissue” and a pending international patent application. This license
agreement requires a royalty be paid on sales of the patent on products using
claims described within the patent under the license. For the fiscal year
ended  December 31, 2008, revenues have been generated from sales of
products using this patent and royalties in an amount of $670 have been
paid.


46





Note 12:
Subsequent Events





Fusion
Capital Transaction





On
January 30, 2009, we entered into a Common Stock Purchase Agreement with Fusion
Capital Fund II, an Illinois limited liability company. Under the Purchase
Agreement, Fusion Capital is obligated, under certain conditions, to purchase
shares from us in an aggregate amount of $6.0 million from time to time over a
twenty-four (24) month period.  Under the terms of the Purchase
Agreement, Fusion Capital has received a commitment fee consisting of 1,094,017
shares of our common stock.  Also, we will issue to Fusion Capital an
additional 547,009 shares as a commitment fee pro-rata as we receive the $6.0
million of future funding.  In addition, in December 2008, we issued
100,000 shares to Fusion Capital as an expense reimbursement.





Under the
Purchase Agreement and the associated Registration Rights Agreement we are
required to register 13,000,000 common shares comprised of: (1) 1,094,017 shares
which have already been issued, (2) an additional 547,009 shares which we may
issue in the future as a commitment fee pro rata as we receive the $6.0 million
of future funding, (3) 100,000 shares we previously issued to Fusion Capital as
an expense reimbursement and (4) at least 11,558,974 shares which we may sell to
Fusion Capital after a registration statement is declared effective. Under the
Purchase Agreement, we have the right but not the obligation to sell more than
the 13,300,000 shares to Fusion Capital. As of the date hereof, we do not
currently have any plans or intent to sell to Fusion Capital any shares beyond
the 13,300,000 shares offered hereby.  However, if we elect to sell
more than the 13,300,000 shares (which we have the right but not the obligation
to do), we must first register under the Securities Act any additional shares we
may elect to sell to Fusion Capital before we can sell such additional
shares.  The number of shares ultimately offered for sale by Fusion
Capital is dependent upon the number of shares purchased by Fusion Capital under
the Purchase Agreement.





We do not
have the right to commence any sales of our shares to Fusion Capital until the
SEC has declared effective a registration statement. After the SEC has declared
effective such registration statement, generally we have the right but not the
obligation from time to time to sell our shares to Fusion Capital in amounts
between $25,000 and $1.0 million depending on certain conditions. We have the
right to control the timing and amount of any sales of our shares to Fusion
Capital.  The purchase price of the shares will be determined based
upon the market price of our shares without any fixed discount at the time of
each sale.  Fusion Capital shall not have the right nor the obligation
to purchase any shares of our common stock on any business day that the price of
our common stock is below $0.15.  There are no negative covenants,
restrictions on future fundings, penalties or liquidated damages in the Purchase
Agreement or the Registration Rights Agreement. The Purchase Agreement may be
terminated by us at any time at our discretion without any cost to
us.  The Purchase Agreement provides that neither party has the
ability to amend the Purchase Agreement and the obligations of both parties are
non-transferable.


stock.





ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.





On April
28, 2008, the Company engaged McGladrey & Pullen, LLP as its new registered
independent public accounting firm, commencing with the review of the quarter
ended March 31, 2008 and including the audit for the fiscal year ending December
31, 2008, and dismissed J. H. Cohn LLP. The decision to change registered
independent public accounting firms was approved by the Audit Committee of the
Board of Directors of the Company.





Our
consolidated financial statements as of December 31, 2007 have been audited
by JH Cohn LLP. The reports of J. H. Cohn LLP on the Company's financial
statements as of and for the year ended December 31, 2007 contained no adverse
opinion or disclaimer of opinion and were not qualified or modified as to audit
scope or accounting principle.





During
the fiscal year ended December 31, 2007 and to April 28, 2008, the Company has
not consulted with McGladrey & Pullen, LLP on any items concerning the
application of accounting principles to a specified transaction, the type of
audit opinion that might be rendered on the Company’s financial statements, or
the subject matter of a disagreement or reportable event with the former auditor
(as described in Regulation S_K Item 304(a)(2)).





During
the year ended December 31, 2007 and the period through April 28, 2008, the date
of dismissal, there were no disagreements between the Company and J. H. Cohn LLP
on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements, if not resolved
to the satisfaction of J. H. Cohn LLP, would have caused them to make reference
thereto in their report on the financial statements for such year.





During the year ended December 31, 2007
and the period  through April 28, 2008, the date of dismissal, J. H.
Cohn LLP did not advise the Company of any reportable events (as defined in
Regulation S-K Item 304(a)(1)(v)).


47




ITEM
9A(T).CONTROLS AND PROCEDURES.





Evaluation
of Disclosure Controls and Procedures





Under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we evaluated the effectiveness of
the design and operation of our disclosure controls and procedures as of the end
of the period covered by this report (the “Evaluation Date”). We reviewed in
particular whether the information required to be disclosed is recorded,
processed, summarized and reported  appropriately within the required
time periods and was accumulated and communicated to management in a timely
manner. We conducted our evaluation consistent with the COSO review framework.
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures provide reasonable
assurance that:





·
            Financial records are maintained
      in reasonable detail to accurately and fairly reflect the transactions and
      dispositions of the Company.


·
            Transactions are recorded as
      necessary to permit preparation of financial statements in accordance with
      generally accepted accounting principles, and that receipts and
      expenditures are being made in accordance with authorizations of
      management and directors of the
Company.


·
            Internal controls provide
      reasonable assurance to prevent or detect in a timely manner unauthorized
      acquisitions, use or dispositions of the Company that could have a
      material effect on the financial
  statements





Evaluation
of Internal Control over Financial Reporting





Management
is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The
Company’s internal control over financial reporting includes those policies and
procedures that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the Company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with authorization of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the Company’s assets that could
have a material effect on the financial statements.





Under
supervision and with the participation of management, including our principal
executive officer and principal financial officer, we conducted an evaluation of
the effectiveness of our internal control over financial reporting based on the
framework in Internal
Control-Integrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on our evaluation under the
framework within the Internal
Control-Integrated Framework,management concluded that our internal
control over financial reporting was effective as of December 31,
2008.





Management’s
assessment of the effectiveness of our internal control over financial reporting
as of December 31, 2008 has not been attested to by McGladrey & Pullen, LLP
the Company’s independent registered public accounting firm as stated in their
report which is included herein pursuant to temporary rules of the Securities
and Exchange Commission that permit the Company to provide only management’s
report within this annual report.





Changes
in Internal Financial Controls





Under the
supervision and with the participation of our management, including our Chief
Executive Officer and Chief Financial Officer, we evaluated any changes to our
internal controls over financial reporting which may have occurred during the
quarter ended December 31, 2008. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that there were no changes in the
Company’s internal controls over financial reporting during the quarter ended
December 31, 2008 which have materially affected, or are likely to materially
affect our internal controls over financial reporting.





ITEM 9B.
OTHER INFORMATION.





None




48




PART
III





ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE.




The
following information is provided with respect to the directors and officers of
the Company:





Name
              
              Age
              
              Director/Officer SinceJim
      Hitchin, Chairman,
      President and CEO
              
              66
              
              2004Jim
      Dorst, Chief Financial
      Officer
              
              54
              
              2007Mark
      McWilliams, Director
              
              52
              
              2004Rand
      Mulford, Director
              
              65
              
              2004John
      Pappajohn, Director
              
              80
              
              2007Stanley
      Pappelbaum, M.D., Director
              
              71
              
              2006Chester
      E. Sievert, Director
              
              57
              
              2004Honorable
      Tommy Thompson, Director
              
              67
              
              2007




Jim Hitchin,
Chairman, President and CEO joined SpectraScience in January 2004 as part
of the bankruptcy acquisition team. For the previous 15 years, he was the
founder, CEO and Chairman of Infrasonics, Inc., a medical device company in the
respiratory care field. Infrasonics was venture funded and completed a
successful initial public offering. Mr. Hitchin served as Chairman, President
and CEO of Infrasonics during its 15 years as a public company. Infrasonics was
the first in its market to have ISO 9001 and the CE Mark for fourteen 510(k) and
two PMA products. Infrasonics revenue growth was at a compound rate of 62%
during its fifteen-year life before being sold to a competitor for 2.5 times
revenue. In previous companies, he was COO of a public energy company and the
VP, General Manager of a public oceanographic engineering firm. Mr. Hitchin has
extensive experience in all phases of manufacturing and company operations, in
particular, sales and marketing of medical devices. He graduated from San Diego
State University with a degree in Physics. The Company maintains key-man life
insurance on Mr. Hitchin in the amount of $2,000,000.





Jim Dorst, Vice President of Finance
and CFO joined the Company in December 2007. Mr. Dorst brings to the
Company over 20 years of senior management experience in finance, operations,
planning and business transactions. Prior to joining SpectraScience, Mr. Dorst
was Chief Financial Officer of Aethlon Medical, Inc., a public medical device
development company. Before joining Aethlon, Mr. Dorst was Vice President of
Finance and Operations for Verdisoft Corporation, a developmental-stage
mobile-software developer acquired by Yahoo, Inc. Previously, he held executive
positions as SVP of Finance and Administration at SeeCommerce, COO/CFO of Omnis
Technology Corp and CFO / SVP of Information Technology at Savoir Technology
Group, Inc. (acquired by Avnet, Inc.). Mr. Dorst practiced as a Certified Public
Accountant with Coopers & Lybrand (PricewaterhouseCoopers) and holds an MS
in Accounting and a BS in Finance from the University of Oregon.




Mark McWilliams,
Director. Since June 2007 he has served as the CEO of Medipacs, Inc a
development stage infusion pump company. Prior to that, from December 2003 to
November 2005 he was Director of Cell Imaging and Analysis at Beckman Coulter
after the recent sale of Q3DM to Beckman in December 2003. He was President and
Chief Executive Officer and Director of Q3DM, from October 2001 to December
2003, a life-sciences startup that raised several angel and venture capital
funding rounds that was acquired by Beckman Coulter. Previously, he was founder
and COO of Medication Delivery Devices (“MDD”), an alternate care infusion
systems company that was acquired by Baxter Healthcare in 1996. Mr. McWilliams
served as a VP of Research and Development at Baxter Healthcare for three years
following the sale of MDD. Prior to MDD, he served as Product Development
Manager at the founding of Block Medical where he was responsible for bringing
the company’s first two FDA approved products rapidly to market. Block was sold
to Hillenbrand Industries in 1991. He previously worked for Hughes Aircraft,
Vacuum General and Martin Marietta. He earned his MSME from the Massachusetts
Institute of Technology, his BSME from Northeastern University and holds eight
utility patents.


49




Rand P. Mulford,
Director. Since November 2005, Mr. Mulford has been one of three founding
partners of Adamis Pharmaceuticals Corporation, which is engaged in developing
anti-viral therapies and operates a specialty pharmaceutical and pharmaceutical
packaging subsidiary. Immediately prior, from July 2003 to October 2005 he
served as E.V.P. for Strategy with Chatham Capital and Forest Health Services.
For the previous two years, he was part of the senior management team of a small
investment banking firm that specialized in funding early stage companies and
technology-based spinouts using private placements. He has worked directly with
four portfolio companies. Mr. Mulford was asked to identify critical issues and
develop business strategy, serve on three of the Boards of Directors, assume a
direct managerial role in two of the companies, and negotiate the successful
sale of one of the companies. His corporate experience includes: Group V.P. of
Planning and Control for a petrochemical company; head of Corporate Planning at
Merck; CFO of a human tissue company; COO of a drug discovery company, and
President of its subsidiary, a research chemical company; COO of a diagnostics
company; Chairman of the Board of a medical device company; and head of
Corporate Development at a bio-pharmaceutical company. Mr. Mulford started his
business career with the consulting firm of McKinsey & Co. in the Chicago
office. During an eight-year period, he served about twenty clients working on a
variety of issues primarily related to strategy and organization. Mr. Mulford
obtained his bachelors degree in engineering with honors from Princeton
University in 1965. For the next five years he served as a naval officer in the
nuclear submarine program. Subsequently, he earned an MBA with high distinction
at Harvard Business School.




Mr. John
Pappajohn, Director. Since 1969, Mr. Pappajohn has been the President and
principal stockholder of Equity Dynamics, Inc., a financial consulting firm, and
the sole owner of Pappajohn Capital Resources, a venture capital firm, both
located in Des Moines, Iowa. He also serves as a director for the following
public companies: Allion Healthcare, Inc., American CareSource Holdings, Inc.,
CareGuide, Inc., and PharmAthene, Inc. Mr. Pappajohn has been an active private
equity investor in healthcare companies for more than 30 years and has served as
a director of more than 40 public companies. Mr. Pappajohn received his B.S.C.
from the University of Iowa.




Stanley J.
Pappelbaum M.D., Director. Dr. Pappelbaum has been Managing Partner of
Pappelbaum, Turner & Associates, a national healthcare consultancy company
that advises hospital, medical group, health insurance, and governmental
healthcare clients since 2000. Dr. Pappelbaum joined Scripps hospital in 1996 as
Chief Transformational Officer in charge of creating and implementing Scripps’
strategic vision of the future. In 1997, he was promoted to Executive Vice
President and Chief Operating Officer and, in 1999, he was promoted to President
and Chief Executive Officer when the hospital reached annual revenues of over $1
billion. From 1985 to 1995, he was the managing partner of Professional Health
Consulting Group, a national company of physician executives who analyzed and
managed change for complex not-for-profit healthcare systems clients throughout
the United States. From 1969 to 1984, Dr. Pappelbaum taught and practiced
Pediatric Cardiology at the University of California, San Diego and at San Diego
Children’s Hospital, where he was Chief of Pediatric Cardiology from 1972-1978.
Dr. Pappelbaum completed his undergraduate work at McGill University, Montreal
and received his medical degree from the University of British Columbia Faculty
of Medicine in Vancouver. He completed his residency in pediatric medicine at
Montreal Children’s Hospital of McGill University and did graduate studies in
cardiovascular physiology and a fellowship in pediatric cardiology at the
University of California, Los Angeles. He also was awarded an Alfred P. Sloan
Fellowship at the Massachusetts Institute of Technology where he earned a
Master's degree in management (health option).




Chester E.
Sievert, Jr., Director. Mr. Sievert has been President of Advanced
Photodynamic Technologies since January 2003. He previously worked at
SpectraScience as a consultant in June 1996, and subsequently held various
executive positions. Mr. Sievert served as Chairman of the Board of
SpectraScience beginning in June 1999. He served as President from March 1998,
and Chief Executive Officer from January 1999 until December 2001. He then
became Executive Vice President of Technology and Chairman of the Board until
September 2002. Prior to joining SpectraScience, Mr. Sievert was a founder and
President of two medical product companies; ReTech, Inc. from 1980 to 1986; and
FlexMedics Corporation from 1986 to 1995. Both Companies were sold to American
Endoscopy, Inc. and Phillips Plastics Corporation, respectively. As a former
Senior Research Health Scientist on staff at the University of Minnesota Medical
School and the Veterans Administration Medical Center, Mr. Sievert has published
more than 50 medical journal articles in the fields of gastroenterology,
endoscopy and fiber optics. He has also been awarded eight United States and
International patents. Mr. Sievert has a Bachelor of Science Degree in
Comparative Physiology from the University of Minnesota.





Honorable Tommy
Thompson, Director. Before entering the private sector in 2005, Secretary
Thompson enjoyed a long and distinguished career in public service. In 1966 he
won a seat in Wisconsin’s state Assembly. He became assistant Assembly minority
leader in 1973 and Assembly minority leader in 1981. Elected Governor of
Wisconsin in 1986, he was reelected in 1990, and in 1994 became the first
Governor in the state’s history to be elected to a third four-year term. In 1998
he was elected to a fourth term, and served in that position until his
appointment as Secretary of Health & Human Services in 2001.





As the
head of the Department of Health & Human Services, Secretary Thompson served
as the nation’s leading advocate for the health and welfare of all Americans. He
worked to modernize and add prescription drug coverage to Medicare for the first
time in the program’s history. A leading advocate of welfare reform, he also
focused on expanding services to seniors, the disabled and low-income
Americans.


50




As
Governor of Wisconsin, Secretary Thompson was perhaps best known for his efforts
to revitalize the Wisconsin economy, for his national leadership on welfare
reform and for his work in expanding health care access across all segments of
society.




Secretary
Thompson is well-known for his contributions to the U.S. response to the threat
of bioterrorism and for his leadership in the fight against HIV/AIDS in the
United States and abroad; from 2003 to 2005, he served as the chairman of the
Global Fund to Fight AIDS, Tuberculosis and Malaria.




Secretary
Thompson has received numerous awards for his public service, including the
Anti-Defamation League’s Distinguished Public Service Award, Governing Magazine ’s Public
Official of the Year Award and the Horatio Alger Award, which is awarded
annually to “dedicated community leaders who demonstrate individual initiative
and a commitment to excellence—as exemplified by remarkable achievements
accomplished through honesty, hard work, self-reliance, and perseverance.” He is
a former Chairman of the National Governors’ Association, the Education
Commission of the States and the Midwestern Governors’ Conference.





Secretary
Thompson received both his B.S. in 1963 and his J.D. in 1966 from the University
of Wisconsin-Madison. He is a member of the District of Columbia and Wisconsin
Bars. He is also on the Boards of CR Bard, Centene Corporation and Pure
Bioscience.





Board Meetings. The Board of
Directors held nine meetings during fiscal 2009. All directors attended at least
75% of the meetings of the Board of Directors and of each committee on which
they served.





Compensation of Directors. The
Company does not pay directors for Board of Directors’ meetings or committee
meetings attended, but reimburses each such director for reasonable travel and
out-of-pocket expenses for attendance at these meetings. Should a director be
required to expend an extraordinary amount of time performing a Company task,
he/she would be compensated at a rate of $100/hour. Several payments were made
in fiscal 2008 to Chester Sievert in an aggregate amount of
$28,761.




Pursuant
to the SpectraScience, Inc. Amended 2001 Stock Option Plan, non-employee
directors McWilliams, Mulford and Sievert were granted non-qualified stock
options to purchase 400,000, 400,000 and 300,000 shares of common stock,
respectively, on July 26, 2004 at an exercise price of $0.15 per share. Dr.
Pappelbaum joined the board on June 2006 and was granted a non-qualified stock
option to purchase 400,000 shares of common stock at an exercise price of $1.09
per share. Mr. Pappajohn joined the board in June 2007 and was granted a
non-qualified stock option to purchase 400,000 shares of common stock at $1.10
per share. Governor Tommy Thompson joined the board on September 20, 2007 and
was granted a non-qualified stock option to purchase 400,000 shares of common
stock at an exercise price of $0.75 per share.  On November 7, 2008
directors McWilliams, Mulford, Pappelbaum and Sievert were each granted
non-qualified stock options to purchase 400,000 shares of common stock at an
exercise price of $0.38.  The exercise prices of the options was based
on the prevailing market price (defined as the closing price) of the common
stock on the date of grant.




The
options granted to employee and non-employee directors under the Amended 2001
Stock Option Plan expire ten years from the date of grant (subject to earlier
termination in the event of death or termination), are not transferable (except
by will or the laws of descent and distribution), and become exercisable in
three equal annual installments commencing on the date of grant except for the
November 7, 2008 grants which commence one year from the date of
grant.




The
following table shows the compensation earned by each of our non-employee
directors as of the year ended December 31, 2008:




DIRECTOR
COMPENSATION





Name
                  
                  Fees
                    Earned
                    or Paid
                    In Cash
                    ($)
                  
                  Stock
                    Awards
                    ($)
                  
                  Option Awards
                    ($)
                  
                  Non-Equity
                    Incentive
                    Plan
                    Compensation
                    ($)
                  
                  Non-Qualified
                    Deferred
                    Compensation
                    Earnings
                    ($)
                  
                  All
                    Other
                    Compensation
                    ($)
                  
                  TotalMark McWilliams (1)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  6,275
                  (2)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  6,275Rand Mulford (1)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  6,275
                  (3)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  6,275Chester Sievert (4)
                  
                  $
                  28,761
                  
                  
                  
                  —
                  
                  
                  $
                  6,275
                  (5)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  35,036Stanley J.
      Pappelbaum, M.D. (1)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  6,275
                  (6)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  6,275John Pappajohn
      (7)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  131,496
                  (8)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  131,496Tommy Thompson(9)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  88,681
                  (10)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  88,681


51




(1)
              The aggregate number of stock
      awards and options awards issued and outstanding as of December 31, 2008
      are 0 and 800,000.
 
 (2)
              On
      November 7, 2008, Mr. McWilliams was granted a non-qualified stock option
      at an exercise price of $0.38 per share. The option vests one-third on
      each annual anniversary date from initial grant and will be fully vested
      on November 7, 2011. The $6,275 represents the non-cash stock option
      expense recognized for the fiscal year ending December 31,
      2008.
 (3)
              On November 7, 2008, Mr. Mulford
      was granted a non-qualified stock option at an exercise price of $0.38 per
      share. The option vests one-third on each anniversary date from initial
      grant and will be fully vested on November 7, 2011. The $6,275 represents
      the non-cash stock option expense recognized for the fiscal year ending
      December 31, 2008.
 (4)
              The
      aggregate number of stock awards and options awards issued and outstanding
      as of December 31, 2008 are 0 and
700,000.
 (5)
              On
      November 7, 2008, Mr. Sievert was granted a non-qualified stock option at
      an exercise price of $038 per share. The option vests one-third on each
      anniversary date from the initial grant and will be fully vested on
      November 7, 2011. The $6,275 represents the non-cash stock option expense
      recognized for the fiscal year ending December 31,
  2008.
 (6)
              On
      November 7, 2008, Dr. Pappelbaum was granted a non-qualified stock option
      at an exercise price of $0.38 per share. The option vests one-third on
      each anniversary date from the initial grant and will be fully vested on
      November 7, 2011. The $6,275 represents the non-cash expense recognized
      for the fiscal year ending December 31,
2008.
 (7)
              The
      aggregate number of stock awards and options awards issued and outstanding
      as of December 31, 2008 are 0 and
400,000.
 (8)
              Mr. Pappajohn was granted a
      ten-year stock option to purchase 400,000 shares of common stock at an
      exercise price of $1.10 per share on June 18, 2007, when he became a
      director of the Company. The stock options vest one-third upon grant and a
      subsequent one-third on each anniversary date thereafter, becoming fully
      vested on June 18, 2009. The $131,496 represents the non-cash stock option
      expense recognized for the fiscal year ended December 31,
      2008.
 (9)
              The
      aggregate number of stock awards and options awards issued and outstanding
      as of December 31, 2008 are 0 and
400,000.
 (10)
              Mr. Thompson was granted a
      ten-year stock option to purchase 400,000 shares of common stock at an
      exercise price of $0.75 per share on September 20, 2007, when he became a
      director of the Company. The stock options vest one-third upon grant and a
      subsequent one-third on each anniversary date thereafter, becoming fully
      vested on September 20, 2009. The $88,681 represents the non-cash stock
      option expense recognized for the fiscal year ended December 31,
      2008.




Code of Ethics. The Company
has adopted a code of ethics applicable to its chief executive officer and
senior financial officer. The code is available at no charge by request to the
Company in writing, to the attention of the CFO. Additionally, the code is filed
with the Securities and Exchange Commission as an exhibit to the Company’s
Report on Form 10-KSB for the fiscal year ended December 31, 2005, and is
available at the SEC website ( www.sec.gov ).





Committees. The Company has an
audit committee, a compensation committee, and a nominating committee, each of
which is comprised of all non-employees (outside directors). The members of
these committees during fiscal 2008 were as follows:





Audit Committee
              
              Compensation Committee
              
              Nominating CommitteeRand
      Mulford, Chairman
              
              Rand
      Mulford, Chairman
              
              Rand
      Mulford, ChairmanMark
      McWilliams
              
              Mark
      McWilliams
              
              Mark
      McWilliamsStanley
      Pappelbaum
              
              Stanley
      Pappelbaum
              
              Stanley
      Pappelbaum




Nominating Committee. The
nominating committee, consisting of non-employee directors, determines the
required selection criteria and qualifications of director nominees based upon
the needs of the Company at the time nominees are considered. In general, at a
minimum, a candidate must possess the ability to apply good business judgment
and must be in a position to properly exercise his or her duties of loyalty and
care. In addition, the committee evaluates candidates based on financial
literacy, knowledge of the Company’s industry or other background relevant to
the Company’s needs, status as a shareholder in the Company, “independence” for
purposes of compliance with the rules of the SEC and the Nasdaq Stock Market,
and willingness, ability, and availability for service. Candidates will be
preferred who hold an established executive level position in business, finance,
law, education, research or government. When current Board members are
considered for nomination for reelection, the nominating committee also takes
into consideration their prior Company Board contributions, performance and
meeting attendance records.




The
nominating committee has not utilized the services of any third party search
firm to assist in the identification or evaluation of Board member candidates.
However, the committee may engage a third party to provide such services in the
future, as it deems necessary or appropriate at the time in
question.




The
nominating committee considers qualified candidates for possible nomination that
are submitted by our shareholders.


52




This
information is evaluated against the criteria established by the committee and
the specific needs of the Company at that time. Based upon such preliminary
assessment, candidate(s) who appear best suited to meet the needs of the Company
may be invited to participate in a series of interviews, which are used as a
further means of evaluating potential candidates. On the basis of information
learned during this process, the committee determines which nominee(s) to
propose for election at the next annual meeting. The committee uses the same
process for evaluating all nominees, regardless of the source of the
nomination.





Audit Committee. The Audit
Committee of the Board of Directors is comprised of three non-employee
directors. All members are independent as defined under the rules of The Nasdaq
Stock Market. The Audit Committee has Rand Mulford, Chairman, serving as an
independent director and financial expert.





The Audit Committee held 5 meetings
during the fiscal ended December 31, 2008. The meetings were designed to
facilitate and encourage communication between the Audit Committee and the
Company’s independent public accountants, McGladrey & Pullen, LLP.
During these meetings, the Audit
Committee reviewed and discussed the quarterly and audited financial statements
with management and McGladrey & Pullen, LLP.





The
discussions with McGladrey & Pullen, LLP also included the matters required
by Statement on Auditing Standards No. 61 (Communication with Audit Committees).
McGladrey & Pullen, LLP also provided to the Audit Committee the written
disclosures and the letter regarding their independence as required by the
Independence Standards Board Standard No. 1. This information was discussed with
McGladrey & Pullen, LLP. Based on these discussions, the Audit Committee
recommended to the Board of Directors that the audited financial statements for
the fiscal year ended December 31, 2008, be included in the Company’s annual
report on Form 10-K.





Shareholder Communication with the
Board. We do not have a formal procedure for shareholder communication
with our Board of Directors. In general, our officers are easily accessible by
telephone or mail. Any matter intended for the Board, or for any individual
member or members of the Board, should be directed to our CFO at the Company
address with a request to forward the same to the intended recipient. All such
communications will be forwarded unopened.




Section
16(a) Beneficial Ownership Reporting Compliance


Based
solely upon a review of Forms 3, 4 and 5 and amendments thereto furnished to the
Company and any written representations that no Forms 5 was required, the
Company believes that all reports required to be filed by its officers,
directors, and greater than 10% beneficial shareholders under Section 16(a) of
the Exchange Act were timely filed.





ITEM 11.
EXECUTIVE COMPENSATION.




Summary
Compensation Table.




Name and
                                                              Principal
                                                              Position
                                                            
                                                            Year
                                                            
                                                            Salary
                                                              ($)
                                                            
                                                            
                                                            Bonus
                                                              ($)
                                                            
                                                            
                                                            Stock
                                                              Awards
                                                            
                                                            
                                                            Option Awards
                                                              ($)
                                                            
                                                            
                                                            Non-Equity
                                                              Incentive
                                                              Plan
                                                              Compensation
                                                              ($)
                                                            
                                                            
                                                            Non-Qualified
                                                              Deferred
                                                              Compensation
                                                              Earnings
                                                              ($)
                                                            
                                                            
                                                            All
                                                              Other
                                                              Compensation
                                                            
                                                            
                                                            Total
                                                              ($)Jim Hitchin - (1)
                                                            
                                                            2008
                                                            
                                                            $
                                                            161,915
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            161,915Chairman,
      President and CEO
                                                            
                                                            2007
                                                            
                                                            $
                                                            48,000
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            48,000Jim Dorst – CFO (2)
                                                            
                                                            2008
                                                            
                                                            $
                                                            152,885
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            144,297
                                                            (3)
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            297,1822007
                                                            
                                                            $
                                                            8,654
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            145,262
                                                            (4)
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            153,916Todd
      Pinkowski–
                                                            
                                                            2008
                                                            
                                                            $
                                                            178,366
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            65,492
                                                            (6)
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            248,358Director
      of Operations(5)
                                                            
                                                            2007
                                                            
                                                            $
                                                            3,365
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            65,393
                                                            (6)
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            68,758Michel
      Vaudry –
                                                            
                                                            2008
                                                            
                                                            $
                                                            176,250
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            600
                                                            (8)
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            176,850Director
      of International Sales(7)
                                                            
                                                            2007
                                                            
                                                            $
                                                            106,923
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            106,923





(1)
            Mr. Hitchin is the Company’s
      Chairman, President and CEO. He does not have a written or unwritten
      employment agreement and his salary is not dependent on performance
      targets, goals or any other conditions. Also he is not subject to
      severance and change of control
  arrangements.





(2)
            Mr. Dorst became the Company’s
      Vice President of Finance and Chief Financial Officer on December 3, 2007.
      He does not have a written employment agreement, his salary is not
      dependent on performance targets, goals or other conditions and he is not
      subject to any severance or change in control
      arrangements.


53


(3)
            The
      $144,297 represents the non-cash stock option expense recognized for the
      fiscal year ending December 31,
2008.


(4)
            Mr. Dorst had previously been a
      consultant for the Company and was granted a stock option to purchase
      400,000 common shares at an exercise price of $0.90 on September 7, 2007.
      The option vests one-third upon grant and an additional one-third on each
      annual anniversary of the grant date, being fully-vested on September 7,
      2009. Included in the Option Award total compensation of $145,262 is
      $134,162 in non-cash stock option expense related to consulting expense
      and incurred prior to his becoming an officer of the
      Company.


(5)
            Mr.
      Pinkowski is our Director of Operations. He does not have a written or
      unwritten employment agreement and his salary is not dependent on
      performance targets, goals or any other conditions. Also he is not subject
      to severance and change of control
arrangement.


(6)
            Mr.
      Pinkowski was granted a stock option to purchase 200,000 common shares at
      an exercise price of $0.96 on December 17, 2007. The option vests
      one-third upon grant and an additional one-third on each annual
      anniversary of the grant date, being fully-vested on December 17, 2009. Mr
      Pinkowski was also granted a stock option to purchase 200,000 common
      shares at an exercise price of $0.25 on December 16, 2008. This option
      vests one-third on the first anniversary of the date of grant with
      one-third vesting each anniversary thereafter, becoming fully vested on
      December 16, 2011. The $65,492 and $65,393 represents non-cash stock
      option expense recognized in fiscal years 2008 and 2007,
      respectively.


(7)
            Mr.
      Vaudry is our Director of International Sales. He does not have a written
      or unwritten employment agreement and his salary is not dependent on
      performance targets, goals or any other conditions. Also, he is not
      subject to severance and change of control
  arrangement.


(8)
            Mr.
      Vaudry was granted a stock option to purchase 400,000 common shares at an
      exercise price $0.15 on July 25, 2004. These options are fully vested at
      December 31, 2008. Mr. Vaudry was also granted a stock option to purchase
      200,000 common shares at an exercise price of $0.25 on December 16, 2008.
      This option vests one-third on the first anniversary of the date of grant
      with one-third vesting each anniversary thereafter, becoming fully vested
      on December 16, 2011. The $600 represents non-cash stock-option expense
      recognized in fiscal 2008.




Pension Benefits. The Company
does not have a pension benefit plan.




Nonqualified Deferred
Compensation. There was no nonqualified deferred compensation in fiscal
year 2008 to officers of the Company.




Life Insurance. The Company
owns a $2 million life insurance policy on the life of our CEO, Mr. Hitchin. The
Company is the beneficiary of the policy.




Grants of Plan-Based Awards, Option
Exercises and Stock Vested. The following table describes the outstanding
stock option grants to executive officers and required additional individuals at
fiscal year end. There are no Stock Awards issued or outstanding.





Outstanding Equity Awards at Fiscal Year End
                    Options AwardsName
                  
                  Number of
                    Securities
                    Underlying
                    Unexercised
                    Options (#)
                    Exercisable
                  
                  Number of Securities
                    Underlying
                    Unexercised Options
                    (#) Unexercisable
                  
                  Equity
                    Incentive Plan
                    Awards:
                    Number of
                    Securities
                    Underlying
                    Unexercised
                    Unearned Options
                    (#)
                  
                  Option
                    Exercise
                    Price
                    ($)
                  
                  Option
                    Expiration DateJim
      Hitchin
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Jim
      Dorst
                  
                  
                  266,667
                  
                  
                  
                  133,333
                  
                  
                  
                  -
                  
                  
                  $
                  0.90
                  
                  
                  
                  09/07/17Todd
      Pinkowski
                  
                  
                  133,333
                  
                  
                  
                  66,667
                  
                  
                  
                  -
                  
                  
                  $
                  0.96
                  
                  
                  
                  12/17/17-
                  
                  
                  
                  200,000
                  
                  
                  
                  -
                  
                  
                  $
                  0.25
                  
                  
                  
                  12/16/18Michel
      Vaudry
                  
                  
                  320,000
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  0.15
                  
                  
                  
                  07/25/14-
                  
                  
                  
                  200,000
                  
                  
                  
                  -
                  
                  
                  $
                  0.25
                  
                  
                  
                  12/16/18


54





ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS.





Summary
of Securities Authorized for Issuance Under Equity Compensation
Plans





The
following table sets forth December 31, 2008 information on our equity
compensation plans in effect as of that date:





EQUITY
COMPENSATION PLAN INFORMATION


(a)
                      
                      (b)
                      
                      (c)Plan category
                      
                      Number of
                        securities to be
                        issued upon
                        exercise of
                        outstanding
                        options, warrants
                        and rights (1)
                      
                      Weighted-average
                        exercise price of
                        outstanding options,
                        warrants and rights
                      
                      Number of
                        securities
                        remaining
                        available for
                        future issuance
                        under equity
                        compensation
                        plans (excluding
                        securities
                        reflected in
                        column (a))Equity
      compensation plans approved by security holders
                      
                      8,150,000
                      
                      $
                      0.58
                      
                      2,142,040Equity
      compensation plans not approved by security holders
                      
                      -
                      
                      
                      -
                      
                      N/ATotals
                      
                      8,150,000
                      
                      $
                      0.58
                      
                      2,142,040





(1) Net
of equity instruments forfeited, exercised or expired.





2001
Amended Stock Option Plan





Our 2001
Amended Stock Option Plan (the "Option Plan") provides for the grant of
incentive stock options (ISOs") to our employees (who may also be directors) and
nonqualified stock options ("NSOs") to non-employee directors, consultants,
customers, vendors or providers of significant services. The Option plan expires
on January 30, 2011. The exercise price of any ISO may not be less than the fair
market value of the common stock on the date of grant and the term shall not
exceed ten years. The amount reserved under the Option Plan equals 15% of the
outstanding shares of the Company totaling 10,292,040 at December 31, 2008. At
December 31, 2008, we had had option grants outstanding for 8,150,000 common
shares under the Plan, with 2,142,040 available for future
issuance.




The
Company’s Option Plan provides that the number of shares of common stock
available for issuance under the plan shall always equal 15% of the number of
shares of common stock of the Company issued and outstanding.


55




OWNERSHIP
OF COMMON STOCK




The
following table shows as of March 25, 2009, the stock ownership of (i) all
persons known by us to be beneficial owners of more than five percent of our
outstanding shares of Common Stock, (ii) each director and each nominee for
election as a director, (iii) the Named Executive Officers (as defined below
under the caption “Executive Compensation”), and (iv) all current directors and
executive officers as a group:





Name and Address of Beneficial Owner
                                                                  c/o SpectraScience, Inc.
                                                                  11568-11 Sorrento Valley Rd.
                                                                  San Diego, CA 92121
                                                                
                                                                
                                                                Number of Shares Beneficially
                                                                  Owned(1)
                                                                
                                                                
                                                                Percentage of
                                                                  OutstandingSharesEuclidSR Partners, LP (10)
                                                                
                                                                
                                                                10,325,142
                                                                
                                                                
                                                                15
                                                                %Jim Hitchin (2)
      (3)
                                                                
                                                                
                                                                9,002,149
                                                                
                                                                
                                                                13Mr. John Pappajohn
      (3)
      (4)
                                                                
                                                                
                                                                8,213,809
                                                                
                                                                
                                                                12Chester E. Sievert
      (3)
      (5)
                                                                
                                                                
                                                                867,500
                                                                
                                                                
                                                                1Rand Mulford (3)
      (6)
                                                                
                                                                
                                                                790,000
                                                                
                                                                
                                                                1Mark McWilliams
      (3)
      (7)
                                                                
                                                                
                                                                608,333
                                                                
                                                                
                                                                *Stanley Pappelbaum
      M.D. (3)
      (8)
                                                                
                                                                
                                                                450,000
                                                                
                                                                
                                                                *Honorable Tommy
      Thompson (3)
      (9)
                                                                
                                                                
                                                                266,667
                                                                
                                                                
                                                                *Jim Dorst (2)
      (9)
                                                                
                                                                
                                                                266,667
                                                                
                                                                
                                                                *Directors
      and executive officers, as a group
                                                                
                                                                
                                                                20,655,124
                                                                
                                                                
                                                                30
                                                                %





*
            Less than
    1%





(1)
            Beneficial ownership is
      determined in accordance with Rule 13d-3(a) of the Securities Exchange Act
      of 1934 and generally includes voting or investment power with respect to
      securities. Except as indicated by footnotes and subject to community
      property laws, where applicable, the person named above has sole voting
      and investment power with respect to all shares of the Common Stock shown
      as beneficially owned by him or
her.





(2)
            Executive
      Officer





(3)
            Director





(4)
            Includes 266,666 shares which may
      be acquired upon exercise of options which are currently exercisable or
      which become exercisable within 60 days following the date of this
      report.





(5)
            Includes 300,000 shares which may
      be acquired upon exercise of options which are currently exercisable or
      which become exercisable within 60 days following the date of this
      report.





(6)
            Includes 400,000 shares which may
      be acquired upon exercise of options which are currently exercisable or
      which become exercisable within 60 days following the date of this
      report.





(7)
            Includes 400,000 shares which may
      be acquired upon exercise of options which are currently exercisable or
      which become exercisable within 60 days following the date of this
      report.





(8)
            Includes 400,000 shares which may
      be acquired upon exercise of options which are currently exercisable or
      which become exercisable within 60 days following the date of this
      report.





(9)
            Includes 266,667 shares which may
      be acquired upon exercise of options which are currently exercisable or
      which become exercisable within 60 days following the date of this
      report.





(10)
            EuclidSR
      Partners, LP owns 6,143,460 shares of Common Stock and is a related entity
      to EuclidSR Biotechnology Partners and Euclid Partners IV, LP, which
      together own 4,181,682 shares. The business address for all Euclid
      entities is 45 Rockefeller Plaza, Suite 3240, New York, New York
      10111.


56


ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE.




In June
2007, a director of the Company, Mr. John Pappajohn, coincident with his
becoming a director purchased $925,000 of the Company’s Series A Preferred
Stock. As an inducement to engage in the Preferred transaction Mr. Pappajohn
also received 213,250 warrants to purchase an equal number of Preferred shares
at a conversion price of $0.50 per share. Also coincident with becoming a
director, Mr. Pappajohn was granted a stock option to purchase 400,000 shares of
Common Stock at an exercise price of $1.10 which, at the time of grant, was
determined to have a fair value of approximately $394,000. On December 31, 2007,
Mr. Pappajohn invested an additional $383,000 and purchased 547,142 shares of
unregistered common stock as a part of the initial closing of the Company’s
Regulation D private placement offering. On March 31, 2008, and pursuant to the
terms of the Certificate of Designation of the Series A Preferred Stock, Mr.
Pappajohn and related entities converted Preferred Stock into 8,000,000 shares
of restricted Common Stock.





Other
than Mr. Hitchin, the remaining directors of the Company are independent in that
they have no relationship to the corporation that may interfere with the
exercise of their independence from management and the Company. No independent
director has a business or family relationship with another director to the best
of management’s knowledge. The Audit and Compensation Committees consist of Mr.
Mulford (Chair), McWilliams and Dr. Pappelbaum.





ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES.





Policy
on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of
Independent Auditor





Our audit
committee of the Board of Directors is responsible for pre-approving all audits
and permitted non-audit services to be performed for us by our independent
auditor.




Independent Public Accountants’
Fees. The firm of JH Cohn LLP, independent public accountants, audited
our financial statements for the year ended December 31, 2007. The firm of Mc
Gladrey & Pullen LLP, independent public accountants, audited our financial
statements for the year ended December 31, 2008.  Representatives of
JH Cohn LLP and McGladrey & Pullen LLP are not expected to attend the annual
meeting.




The
following table presents fees for professional services rendered for the two
most recent fiscal years.





Year Ended December 31,
                                          2008
                                        
                                        
                                        
                                        Year Ended December 31,
                                          2007Audit fees (1)
                                        
                                        $
                                        104,000
                                        
                                        
                                        $
                                        93,550Audit-related
      fees
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Tax
      fees
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Tax
      compliance fees
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Other
                                        
                                        
                                        -
                                        
                                        
                                        
                                        11,579$
                                        104,000
                                        
                                        
                                        $
                                        105,129





(1)
            Audit fees include fees billed
      and expected to be billed for transition period ended December 31, 2008
      and fees billed and expected to be billed for professional services
      rendered for the audit of our annual financial statements for that period,
      the review of our financial statements included in our reports on Form
      10-Q, services in connection with registration statements filed with the
      SEC, and accounting consultations necessary for the rendering of an
      opinion on our financial
statements.




Our Audit
Committee must pre-approve all audit services, engagement fees and terms, and
all permitted non-audit engagements, subject to the de minimus exceptions
permitted pursuant to the Securities Exchange Act of 1934. .





ITEM 15.
EXHIBITS





The
following documents are filed as part of this report on Form 10-K:




Exhibits Required by Item
601 of Regulation S-B





Exhibit No.
                
                Description3.2
                
                Luma
      Acquisition Agreement (1)3.1
                
                Amended
      and Restated Articles of Incorporation (2)3.2
                
                Bylaws
      (2)


57





4.1
              
              Certificate
      of Designation Series A Preferred Stock (4)4.2
              
              Series
      A Preferred Stock Warrant (4)4.3
              
              Common
      Stock Purchase Warrant issued to Placement Agent (6)10.1
              
              Common
      Stock Purchase Agreement dated as of January 30, 2009, by and between the
      Company and Fusion Capital Fund II, LLC (6)10.2
              
              Registration
      Rights Agreement dated as of January 30, 2009, by and between the Company
      and Fusion Capital Fund II, LLC. (6)10.27
              
              Amended
      SpectraScience Inc, 2001 Stock Plan (2)10.28
              
              Form
      of Directors’ Option Agreement (3)14
              
              Code
      of Ethics (3)16
              
              Letter
      re: Change in Certifying Accountant (5)21
              
              Subsidiaries
      of the registrant23.1
              
              Consent
      of Independent Registered Public Accounting Firm – J.H. Cohn
      LLP23.2
              
              Consent
      of Independent Registered Public Accounting Firm – McGladrey & Pullen
      LLP31.1
              
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200231.2
              
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200232.1
              
              Certification
      of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 200232.2
              
              Certification
      of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002





(1)
            Incorporated
      by reference to the Company’s Report on Form 8-K filed on November 13,
      2007.(2)
            Incorporated
      by reference to the Company’s Report on Form 8-K filed on August 6,
      2004.(3)
            Incorporated
      by reference to the Company’s Report on Form 10-KSB for the fiscal year
      ended December 31, 2005, filed on March 31, 2006.(4)
            Incorporated
      by reference to the Company’s Report on Form 10-QSB for the quarter ended
      June 30, 2007, filed on August 14, 2007.(5)
            Incorporated
      by reference to the Company’s Report on Form 8-K filed on May 2,
      2008(6)
            Incorporated
      by reference to the Company’s Report on Form 8-K filed on January 30,
      2009


58





SIGNATURES




Pursuant
to the requirements of Sections 13 and 15(d) of the Securities Exchange Act of
1934, as amended, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.




SpectraScience,
      Inc.
              (Registrant)Date:
      March 30, 2009
            By:
            /s/
        James HitchinJames
      Hitchin-President, Secretary, and
              Chief
      Executive Officer




Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.


/s/
      James HitchinJames
      Hitchin
                                            
                                            Date:
      March 30, 2009(Principal
      Executive Officer)/s/
      James DorstJames
      Dorst
                                            
                                            Date:
      March 30, 2009(Principal
      Financial and Accounting Officer)/s/
      Mark D. McWilliamsMark
      D. McWilliams
                                            
                                            Date:
      March 30, 2009Director/s/
      Rand P. MulfordRand
      P. Mulford
                                            
                                            Date:
      March 30, 2009Director/s/
      John PappajohnJohn
      Pappajohn
                                            
                                            Date:
      March 30, 2009Director/s/
      Stanley J. PappelbaumStanley
      J. Pappelbaum
                                            
                                            Date:
      March 30, 2009Director/s/
      Chester E. SievertChester
      E. Sievert, Jr.
                                            
                                            Date:
      March 30, 2009Director/s/
      Tommy ThompsonTommy
      Thompson
                                            
                                            Date:
      March 30, 2009Director


59